Financial Focus On...Buy-To-Let Mortgage Interest
14th October 2015 by Robin Beadle
One of the bombshells in the Summer Budget was the proposal to restrict the amount of loan interest relief available on let property, aimed squarely at the Buy-to-Let landlord. As being a landlord is proving a regular occupation for many, this tweak in the rules could have far reaching effects over some property portfolios, large and small. At the time of writing, this is still a “White Paper” proposal and not in its final legislative form. However, the current proposals are that:
- It will affect individuals, not companies
- It is aimed at residential letting (and will not apply to Furnished Holiday Lettings, commercial letting, property development or a trade in dealing in properties)
- Claims for “finance costs” (not just loan interest) have to be restricted to 75% of actual costs in 2017/18
- This restriction increases by a further 25% in each subsequent tax year, becoming fully effective from 2020/21 onwards, when no finance costs can be set directly against rental income.
- Instead, landlords can claim a limited deduction from income tax with regard to finance costs that can no longer be deducted.
- Relief cannot be used to create or increase a loss
If we ignore the complicated maths surrounding its tapered introduction, the end result of the new legislation is to allow tax relief on finance costs only at the basic (20%) rate of tax. The relief will be granted as a non-repayable reduction in your income tax liability equal to 20% of the finance charges (loan interest, mortgage arrangement fees, etc) suffered. The larger the loan or the larger your other income the greater the chance that the new rules will reduce your tax relief and increase your overall tax liability.
To see how you would be affected, as a very quick rule of thumb using 2015/16 figures (and assuming that the new rules are fully in effect), take your usual gross annual rental income and deduct your usual letting expenses, other than loan interest. Let’s call this result your New Net Profit (NNP). Now, if your NNP is positive and when added to your other gross taxable income the total is less than £42,385, you should not be affected by the new legislation. (£42,385 is the point at which 40% income tax starts to be paid, assuming a full personal allowance and standard basic rate band). If your total income plus your NNP is above £42,385, the new rules will increase your income tax liability and the extent of this will be on an individual basis depending on how large your finance charges are and how much other taxable income you receive. If your NNP is negative (you are currently making losses) the new rules will have the effect of reducing the amount of loss to be carried forward, however in this situation it is possible to also carry forward excess finance costs.
So what practical steps can you take? Firstly don’t panic and be forced into rush decisions. The legislation is still draft and there is time to make changes if needed before the new rules bite. Secondly, do the maths as everyone will be affected differently. Third, take professional advice.
If you are affected, there will, however, be four main options:
- Sell up;
- Do nothing and pay any additional tax;
- Move the property to an unaffected spouse (subject to possible remortgaging / refinancing issues)
- Transfer the property into a limited company;
The first two are pretty self-explanatory (other than you would, of course, need to consider any Capital Gains Tax (CGT) issues if selling) and the third may only be possible in limited circumstances.
If you are looking at the last option, tread very carefully. Using a company should not be undertaken lightly (no matter how easy it may be to buy an “off-the-shelf” limited company) as there could be Stamp Duty as well as CGT to consider on any transfers into the company. Once inside, withdrawing money from a company can be complicated and has to be done in a certain number of prescribed ways, each with their own tax implications. You have to remember that it is not “your” money – it belongs to the company. There is more administration and cost involved and your accounts are publicly available. Although individual shares may be easier to gift (compared to shares of a property), when selling up, first the company must sell the property and then you have to liquidate your shares – potentially a double tax charge for CGT. Investment properties within companies are not that efficient for Inheritance Tax purposes and sometimes can even become liable to the Annual Tax on Enveloped Dwellings. That said, for portfolios without large uncrystallised capital gains, portfolios where the income is not needed to live on or for long term usage, the use of a company could be the most tax efficient route.
Finally, the new rules will mean that it will be even more important that a furnished holiday letting continues to qualify as that each year (using the year of grace election if needed) in order to prevent the situation whereby you drop into the new rules one year and back out again the next.
As they say on Crimewatch “Try not to have nightmares”
For further information on any of the above points or to discuss your tax affairs generally, please do not hesitate to contact Robin Beadle.
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