Residential Landlords – The Tax Hike!

Since the summer Budget announcement that from April 2017 interest charges on property borrowing is to be restricted in calculating taxable rental profit, there is not a day that goes by when an individual or an article mentions the change.

Following the Budget the National Association of Landlords has made representations to the Government regarding stopping the changes. There is an online petition (“Say No to George”) calling for the changes to be withdrawn.

However, following other reports and comments that have been made since the announcement, such as house prices continuing to grow (the Chancellor’s reason for the change is to take the “steam” out of the housing market), the Governor of the Bank of England’s concerns with the housing market and his wish to bring buy-to-let mortgages in line with retail mortgages, it is unlikely the policy will be stopped. The Council of Mortgage Lenders (CML) recently released their monthly lending trends report for June 2015, which showed the number of buy-to-let loans provided to UK investors rose 38% in the year to June 2015, to 22,100.

As it looks like we will have to live with the changes, the debate is whether to acquire new property and/or transfer existing property into a limited company. Limited companies are currently excluded from the changes. This is not a new debate, before the changes were announced, we have been asked regularly if a property investor should operate their portfolio via a limited company or in their individual name. Those with high borrowing costs have generally opted for individual ownership, where the costs have reduced taxable profits to nil or to a small profit, but not after 2017!

The key message from the Budget announcement is that if you are a higher rate taxpayer with a mortgage you will pay substantially more in tax (landlords with no borrowing are unaffected), which for some could mean they pay more in tax, than they actually make in “true” profit, making the investment unviable. Aside from the additional tax to be paid, it could also result in landlords losing child benefit or their personal allowances, as their total taxable income increases due to the changes. By way of example, a higher rate tax landlord with an annual net rent of £10,000 and mortgage interest cost of £8,000 would in 2020 have a tax liability of £2,400. When this is added to the mortgage cost the total cost is £10,400 compared to rental income of £10,000 – a loss of £400. The cash flow problem is even worse if the mortgage payments include capital repayments as well as interest.

The changes will be phased in over four years, until borrowing costs will be fully restricted to basic rate income tax (20%) by April 2020. Our summary of the changes can be found at our website.

Change to a Limited Company

The answer being “pushed” by many commentators is to change to a limited company, however this may not be the answer for everyone.

Currently limited companies are excluded from the proposed rules and only pay 20% corporation tax on taxable profit and chargeable gains (reducing to 18% in 2020). However, this is only one level of tax, if the landlord wishes to withdraw the profit from the company, then there is a second level of tax. Profits extracted from the company, generally as dividends, face a personal income tax charge. The taxation of dividends is changing from April 2016 (again a summer Budget announcement), with a higher rate tax payer being charged 30.6% and an additional rate taxpayer 38.1%. For a higher rate taxpayer this would result in a total tax charge of 50.5%, if profits are withdrawn, for example if a property is sold and the profit is required for personal reasons. Further details on the dividend changes can be found here.

In addition to the double layer of taxation, for those with existing property, there can be costs in transferring the property into the limited company, such as stamp duty land tax and capital gains tax. There are also additional costs in running a limited company and with the company having to prepare annual accounts which are filed at Companies House, certain information is placed in the public domain.

Whether changing to a limited company is the correct course of action, depends on the landlord’s situation, for those who only have one property or are a landlord by mistake (having to rent property due to relocating for employment), a limited company may not be the best option. For those with large property portfolios and long-term property investment plans, then a limited company may work. Other options to consider are:

• if you are married, setting up a property partnership business;
• if your spouse is a basic rate taxpayer, transferring ownership to them or
• trading as a furnished holiday let business which is exempt from the proposed rules (this latter option is difficult as there a number of conditions that have to be met).

Harbour Key act for a large number of landlords and can help with the decision process and subsequent implementation. For those existing landlords who wish to consider transferring their current property portfolio, it may be possible to do so without a capital gains tax and/or a stamp duty land tax charge. Each situation will be different and will need to be reviewed to establish the best structure for the landlord and, if the change to a limited company is the right decision, how this can be achieved at minimum tax cost.

Should you wish to review your position, please do not hesitate to contact us to discuss.