Changes to tax relief for residential landlords – Who is affected?
Landlords who pay tax at the higher rate of 40% face important changes to the way mortgage interest is treated for tax purposes. HM Revenue and Customs’ newest rules will have an impact on the amount of tax buy-to-let landlords and investors will have to pay. Starting with the tax year 2017/18, you will still be able to deduct some of your finance cost but if you pay tax at 40% the amount of mortgage or loan interest that can be claimed as a finance cost will be restricted to the basic rate of Income Tax as follows:
2017/18 – 75% of mortgage interest allowed at the higher rate
2018/19 – 50% allowed at the higher rate
2019/20 – 25% allowed at the higher rate
2020/21 – 0% at the higher rate.
This means that Landlords will only receive 20% relief on the mortgage interest that the pay. Starting with the tax year 2017/2018, a reduction in the allowance of this expense could cause you, the Landlord, to have a higher liability due to HMRC.
The following example should help in understanding how the rules apply:
|Repairs, council tax, other expenses||£2,000.00|
|Portion of Mortgage Interest disallowed in 2017-18 (25%)||-£750.00|
|Tax on profit (40%)||£2,300.00|
|HMRC relief is 20% of the £750 that they disallowed||-£150.00|
|Actual tax due||£2,150.00|
Is there an alternative?
Due to these changes many landlords have considered using a Limited company as an alternative to owning a buy-to-let property. First of all let’s consider the advantages and disadvantages of using a Limited Company.
Advantages of using a limited company
- No restriction on the amount of interest paid by the company to finance a buy-to-let property chargeable against company profits.
- Tax on profits is charged at 20% whatever the profit and forecast to reduce as corporation tax rates come down further. This is very important where a Landlord is investing funds to grow a portfolio of properties or to take advantage of other investment opportunities.
- First £5,000 of dividends drawn in the year 2017/18 is tax free. (However starting with the tax year 2018/19 the tax free allowance on dividends is reduced to £2,000).
- No income tax payable as long as the profits are re-invested in the business and no dividends are drawn.
Disadvantages of using a limited company
- The annual exempt amount available to individuals when they make capital gains on the sale of the property is not available
- If profits are extracted in the form of dividends than after the tax free allowance, tax is charged at 7.5%, 32.5% and 38.1% depending on the tax band the overall income level falls within. For higher rate tax payers this could be significant as tax will be charged at the rate of 32.5% in addition to the 20% corporation tax already charged on the company profits.
- Running a limited company is generally more expensive. Higher legal and accountancy costs may be significant.
- Capital gains tax is chargeable at the lower rate of 10% for basic rate tax payer. A private landlord therefore may chose to sell a property when he has limited overall income and thus taking advantage of the lower rate of 10%. A company will always be taxed at the prevailing corporation tax rate of 20%.
- The indexation allowance on capital gains is no longer available as it has been frozen for disposal of assets on or after 1 January 2018 so that corporation tax relief is only available for indexation up to the end of December 2017. The indexation allowance allowed companies to reduce the value of the gain.
What are the implications of transferring a buy-to-let property into a company?
- Stamp duty is payable at the market price of the property even if the property is gifted to the company. High legal fees are payable to transfer the title.
- Capital gains tax is potentially payable by the Landlord as the transfer crystallises the current market value of the property. However, incorporation relief is available based on the following guidance in the HS276 helpsheet.
- However, HMRC may not agree that the Landlord is actively involved in running a business based on buy-to-let properties and may not allow incorporation relief. There are various suggestions as to what constitutes involvement but HMRC’s own interpretation is that a Landlord working 20 hours a week on the business would be regarded as evidence that incorporation relief is available.
Generally for Landlords who pay tax at the higher rate there is a strong argument to consider setting up a limited company for the purpose of purchasing a buy-to-let property or properties. However, where a buy-to-let property already belongs to the individual Landlord we would advice cautiousness before deciding to transfer the property to a limited company.
We encourage our clients with properties and buy-to-let properties to seek advice at an early stage or call us now on 020 8857 5781 or complete the contact form available on our website