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Buy-to-let tax changes to hit landlords

Thousands of local landlords are facing a cut in tax relief on loans, potentially forcing them to make substantial changes to their businesses.

Landlords who own residential property are to face cuts in tax relief on finance costs, including mortgage interest, with the result that many will have to pay more income tax on rental income.

“As a result, some landlords may find they are paying more in tax than they are receiving in net rental income,” warns Lee Blackshaw from the Manchester office of Smith & Williamson, the accountancy and investment management group.

Who will be affected?

As a rule of thumb, if mortgage interest payments are more than approximately three quarters of the rent after deducting other costs, a landlord paying income tax at 40% will find their tax bill wipes out any profit on the rent“ warns Lee.

Therefore, those who have borrowed heavily against the value of their property are likely to suffer the most, while those who own the property outright, without any loans, will not be affected by the income tax changes.

How much?

“For example, at one extreme, suppose you have £10,000 net property income after loan costs of £90,000 a year, you currently pay £2,000 tax at 20%. Under the new rules, you could trip into the 40% tax rate and get an additional tax bill in excess of £22,000, leaving you with a cash deficit. This is essentially because rental income will be assessed for tax before finance costs are taken into account,” explains Lee.

“Even someone in a more modest situation, earning at or just above the higher rate threshold, with, say, gross rents of £20,000 and mortgage interest of £15,000 a year could find that their profit is eliminated by the new tax charge.

“An increase in interest rates could make the situation even more difficult, especially for landlords with larger loans.”

Options

Because of these new rules, landlords should consider the way in which they own rental property.

“For some, it will be more appropriate to hold property in a corporate structure; however, investors may need help in setting up a more sustainable arrangement,” continues Lee.

When?

The changes are being phased in gradually between 6 April 2017 and 5 April 2021. However, because of the far-reaching implications and illiquid nature of property, landlords are urged to review their situation in plenty of time.

New replacement allowance puts an end to ‘wear-and-tear’ tax relief

Additionally, from April 2016 owners of buy-to-let properties, whether furnished or unfurnished will be able to make a specific claim for the actual cost of replacement furniture, furnishings, appliances and kitchenware provided for their tenant’s use in the house. This can include, for example, beds and linen, through to free-standing fridges and cutlery. The replacement of fittings, such as elements of a fitted kitchen, are to continue to be treated as allowable repairs.

The new allowance replaces the 10% ‘wear-and-tear’ allowance available to landlords of fully furnished properties, on 5 April 2016.

This was posted in Bdaily's Members' News section by Smith & Williamson .