Individuals who receive rental income derived from the letting of residential property in the UK or elsewhere (not furnished holiday accommodation) are about to see a significant change to the tax reliefs available upon finance costs (eg mortgage interest, fees incurred in remortgaging) that could endanger the future viability of your portfolio.
The Government announced that the tax relief available to an individual who is letting out residential property is intended to be restricted to only basic rate relief, with the impact being introduced gradually from 6th April 2017 – just over a year away if you need to consider your options which many will probably either want to or need to!
Landlords will be able to obtain relief as follows for finance costs:
>> Up to 5th April 2017, no change to the rules and tax relief granted 100% against property income
>> In 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
>> In 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
>> In 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
>> From 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction
If you are a landlord who only pays basic rate tax – do not worry, nothing is changing for you.
However, if you pay tax at 40-45% these changes are significant and a full strategic review with your adviser is recommended to assess the full impact upon your taxation position and even the viability of your portfolio in the longer term. Not convinced? Consider this example.
Assume that, before lettings income, that your gross earnings match exactly the level at which you extinguish your full basic rate tax entitlements. In effect, the rental pro ts will be taxed at 40% up to a level of £100,000 total gross earnings. National insurance is ignored in this example.
Your gross rents, net of expenses except finance costs, amount to £50,000. You have mortgage interest costs of £37,500 per annum.
Currently, your taxable pro t would be £12,500 upon the portfolio, taxed at 40%. Tax of £5,000 payable.
The new rules, by 2020/1, would see the profits from the rental operation being deemed to be £50,000, before finance cost relief. Taxable at 40%, £20,000. Deduct basic rate relief upon the £37,500 finance costs of £7,500. Tax payable of £12,500.
250% higher than under the old rules, and the entire profit in this example.
You may want to consider buying and /or transferring rental property into a limited company – the way that corporate tax is structured would suggest that full relief will remain available through corporate entities, especially as the HMRC proposal is entitled ‘Restricting finance cost relief for individual landlords!
Landlords with an existing portfolio and who are likely to have additional tax to pay under the proposals have just under two years to consider how best to counter this measure – whether to:
>> Sell up, or
>> Transfer the property into a limited company (which could involve paying Stamp Duty Land Tax and potentially Capital Gains Tax on the sale – as well as arranging a new mortgage), or
>> Do nothing and pay any additional tax