Owning a property for investment purposes is more popular than ever with many people viewing this as an attractive addition to a potentially poor performing or even non-existent pension fund.
George Osbourne announced tax changes for buy to let mortgages for individuals, reducing tax relief on interest on buy to lets to 20% by 2020. This reduction is set to commence from April 2017.
How does this impact you?
If you are a higher rate tax payer (40%) or an additional-rate payer (45%) the tax change means that the maximum tax relief on interest payments is 20%. This not only creates a higher tax bill but reduces profit and yields and in some cases could even create a loss.
Annual rents: £12,000
Annual Interest payable: £6,600
A higher rate tax payer will currently pay £2,160 tax per annum leaving a profit after tax of £3,240. With the revised legislation the tax payment will increase to £3,480 per annum leaving a profit after tax of £1,920, almost a 41% reduction in profit after tax!
How can Landlords overcome this problem?
Addressing the inevitable is all going to be down to landlords’ individual circumstances. If accessing the cash earnt is necessary on a regular then landlords may look to increase rents rather than seek alternative tax saving structures.
Areas that you can consider;
- Review your current buy to let mortgage to see if you are getting the best deal possible. Contact a mortgage advisor for the best deals on the market, according to CMP Services there are some competitive fixed rates to be bagged at present.
- Ensure that you are utilising both you and your partners’ personal allowance to the fullest.
- Form a Limited Company (see below).
- Increase rents, although this will be dependent on market performance at the time.
- Review your current portfolio. It may be time to sell some of your properties or pay off some of those loans.
Forming a Limited Company
Whilst the tax relief is reducing for individuals this is not the case for companies. All allowable business expenses can be offset against rental income and corporation tax is payable on the remaining profit.
Corporation tax for small companies is currently 20% and this will be further reduced to18% by 2020. On the example above profit after tax will be £4,320 at 20% and increasing to £4,920 by 2020.
Profits can be drawn from the company be means of dividend payments. The current dividend structure is being replaced in April 2016 to the following:
- Tax free allowance £5,000
- Basic rate 7.5%
- Higher rate 32.5%
- Additional rate 38.1%
Assuming no dividends are received from other sources the profit after corporation tax (shown above) will be below the dividend tax free allowance of £5k, meaning that the full profit can be taken as dividends with no further tax liability.
There are a number of factors to be considered when forming a Limited Company, such as increased statutory reporting, however a good accountant can help with all this and their fees would be an allowable expense against any profits!
Be aware of potential tax costs on transferring assets from personal ownership to a company, such as stamp duty and capital gains tax. Get all the facts on your numbers before making any decisions.
Wear and tear allowance
Currently, landlords are able to claim a “wear and tear” allowance, helping them to reduce the amount of tax payable. This allowance has been available whether or not the landlord replaces the furnishings within the property. From April 2016, this will be replaced with a new system which allows tax relief only at such time that the times are actually replaced.