Summer Budget 2015 – LandlordsLandlords

We predicted in our June newsletter that the Chancellor may hit landlords. With a lot of talk about helping first time buyers, right to buy, the pension liberation rules etc., we thought there would be some measures to take some steam out of the housing market and that mortgage interest relief for landlords could be scrapped. Some commentators have stated that it is a subsidy for buy to let investors, where there are no equivalent subsidies for home owners and this would provide a solution together with measures to assist with the building new homes.

Restricting interest relief was the biggest announcement in the budget for landlords and we thought we should contact all our landlord clients, in addition to our normal budget summary, to make sure all are aware of the forthcoming changes.

Restriction of interest relief for individual landlords

New rules, subject to a “policy paper” which we are sure there will be considerable debate with interested parties before implementation, will be phased in which will restrict tax relief for the finance costs for higher rate taxpayers who use loans to finance buy-to-let properties. Relief will be restricted to basic rate (20%) only by April 2020. Finance costs include loan interest and arrangement fees. The changes is only effect individual landlords of residential property.

This restriction will be phased in over four years, starting from April 2017 as follows:

  • 2017/18 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available for basic rate relief;
  • 2018/19, 50% finance costs deduction and 50% given as a basic rate tax reduction;
  • 2019/20, 25% finance costs deduction and 75% given as a basic rate tax reduction and
  • 2020/21 all financing costs incurred by a landlord will be given only basic rate tax relief.

For 2020/21 onwards the restriction will be given by ensuring that the deduction from net rental profits is restricted to 20% but any excess financing costs can be carried forward to later years subject to the overriding 20% limit of net rental profits.

We have set out on the following page some examples of how we understand the changes will impact individuals when full implemented, if the legislation is as per the budget announcement. In each example the landlord has the same property valued at £250,000 receiving a rent of £17,000 before letting and other costs of £2,000 and who has a mortgage of £180,000 with an interest cost of £9,000. Thus profit before rental interest is £15,000 and after interest it is £6,000.

Example 1 – Basic Rate Taxpayer tax year – 2020/21

% Tax Current Rules Budget Proposals
£ Tax £ Tax
Salary £25,000 £25,000
Taxable rental profit £6,000 £15,000
Taxable income / profit £31,000 £40,000
Tax band Tax band
Tax at 0% £12,000 £0 £12,000 £0
20% £19,000 £3,800 £28,000 £5,600
Less tax relief on interest 20% £9,000 -£1,800
Total tax £3,800 £3,800

For a basic rate taxpayer, there should be no change in the overall tax liability.  As an employee the taxpayer would have suffered PAYE on their salary having already paid £2,600 of PAYE leaving £1,200 of tax to pay on the rental income – i.e. 20% of his taxable rental profit of £6,000.

Example 2 – Higher Rate Taxpayer tax year -2020/21

Taxpayer earns a salary of £75,000.  The position is altered as follows:

% Tax Current Rules Budget Proposals
£ Tax £ Tax
Salary £75,000 £75,000
Taxable rental profit £6,000 £15,000
Taxable income / profit £81,000 £90,000
Tax band Tax band
Tax at 0% £12,000 £0 £12,000 £0
20% £38,000 £7,600 £38,000 £7,600
40% £31,000 £12,400 £40,000 £16,000
Less tax relief on interest 20% £9,000 -£1,800
Total tax £20,000 £21,800

In this case the total tax bill has gone up by £1,800 due to the restriction on interest relief to 20% on £9,000 of interest expense – so £9,000 x (40% – 20%).  The taxpayer will have already paid £17,600 of PAYE and so the tax on net rental income of £6,000 has effectively risen from £2,400 (£20,000 – £17,600) to £4,200 (£21,800 – £17,600) – an effective tax rate of 70% on net profit.

These rules will not apply where the property meets the criteria of a furnished holiday letting, nor

does it apply to corporate landlords, just individuals.

If considering buying a new rental property with a buy to let mortgage then you could consider making the investment through a limited company as there is currently no proposal for restricting the deduction of financing costs within companies. The changes are headed “Restricting finance cost relief for individual landlords.” However, many landlords already debate whether they should run their buy to let property via a limited company before the changes, one of the reasons for not changing is the capital gains tax implications and depends on the landlord’s long-term intentions. The fact that the Chancellor also announced that corporation tax will be reduced to 19% from 2017 and 18% from 2020 could be a further incentive to switch borrowing vehicle. However, currently buy-to-let products for limited companies cost more and there are fewer choices, but as demand increases, this may change.

In addition to the possible taxation changes to interest relief, the Bank of England is reviewing the buy to let mortgage market, to see if the rules should be changed to bring in line with the retail market mortgage, bringing in more stringent checks and financial reviews.

Wear and tear allowance

Currently where a residential property is let out on a furnished basis, rather than claiming on an actual spend basis, taxpayers can elect to deduct the Wear and Tear Allowance from their taxable rental income, to cover the expense of replacing furnishings. This Wear and Tear allowance is calculated as 10% of the relevant rental income. No Wear and Tear Allowance is available for unfurnished rental residential properties.

As per the summer budget, subject to a short consultation, from April 2016, the Wear and Tear allowance will be replaced with a new relief that will be available to all residential landlords, whether the property is let furnished or unfurnished. This relief will be based on the actual costs of replacing the furnishings supplied. Capital allowances will continue to apply to qualifying holiday lets. A full technical consultation regarding the form of the relief will be issued this summer.

Reforming this relief seems sensible and hopefully will remove the tax anomaly for landlords between renting a property on a furnished and unfurnished basis.

The change we think has been introduced following the withdrawal of the renewals basis last year and to make the system simpler and fairer, by covering both furnished and unfurnished properties.

Rent a Room Relief

The amount of income you can earn before paying tax on renting a room at your home, will be increased from £4,250 to £7,500 from April 2016.

The rate has not been increased for 18 years.

Harbour Key Limited

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 20 July 2015