Here’s a guest blog from Phil Hendry, Director of Reddington Wealth Management Ltd (Partner Practice of St James’s Place), who provides wealth management and tax planning advice. Phil has provided us with advice relating to tax changes which impact on the Buy to Let market and how landlords can ensure their investments give them the best possible return.
Now we are into the new tax year, significant changes to the Buy to Let property market introduced by George Osborne are all in play. It is clear that they will have a huge impact on current buy to let investors, so, just to revisit the key changes briefly:
- Replacement of the 10% Wear and Tear Relief – Up until the turn of the tax year, landlords (of furnished properties) could reduce their annual rental profits by up to 10% to reflect a loss in value, or replacement, of furnishings. This was permitted regardless of whether any maintenance of replacement occurred. This has been replaced with a tax relief against only the replacement of the existing furnishings – and no longer can relief can be claimed against the depreciation or purchase of new items.
- Additional 3% Stamp Duty / LBTT on purchase – This is known as the ‘Additional Dwelling Supplement’, it adds 3% to the rate of tax paid for each portion of the property purchased and will be payable on properties from just £40,000 in Scotland.
- Mortgage Interest Relief to be limited to 20% from 2020 – Tax relief on the finance costs of a buy to let property / second home will be gradually capped at 20% over the next 4 years, rather than against the owners marginal income tax rate. This would have been able to provide relief of up to 45% for additional rate tax payers but will be restricted to basic rate tax relief (20%), reducing the tax efficiency of geared buy to let residential portfolios.
The implications of capping mortgage interest relief is something which unfortunately many buy to let investors will not pay enough attention to until it is too late to act.
To provide a simple example on the finance relief alone; a higher rate investor owns a £200,000 buy to let property, with a mortgage of £150,000, and receives £8,000 annual rental income. The investor’s mortgage interest rate is 3%, so they pay £4,500 in interest. Under previously rules, this would mean the tax payable on rental profits would have been £1,400, but under new rules this would rise to £2,300.
So, how can investors who want to remain in the Buy to Let market ensure their investments give them the best possible return by making this as tax efficient as possible? Unfortunately, very little with regards to the loss of the Wear and Tear allowance and increase in Stamp Duty / LBTT. There are however some measures which will help the changes to mortgage interest relief:
- The simple obvious solution is pay off your buy to let mortgage…but sadly not many people are in that position!
- Remortgage to reduce the amount of annual interest payable. With interest rates at historic lows, and looking unlikely to rise soon, locking in a low interest rate could stave off the effects of the changes for the length of the initial mortgage deal.
- Downsize your buy to let property portfolio to a level where no borrowing is required, or where it is reduced to a level where it becomes profitable again, albeit you’ll lose out on the potential capital growth of a larger portfolio.
- Ensure the property is held / bought in the right family members name. If one spouse or children within a family have little or no earnings, they can earn up to £43,000 per year before paying higher rate tax. As the new legislation begins to have an effect when rental income takes buy to let investors into the higher rate, holding the property in a lower income earners name would completely alleviate the problem.
- The buy to let investor could make a pension contribution to reduce their marginal income tax rate. If an individual made a pension contribution equal to the amount of their rental income taxed at higher rate, this would provide relief on the additional tax paid. Certain pension arrangements also allow investment in Commercial Property, so any pension contributions could be earmarked for a further property purchase.
- Purchase your buy to let property within a limited company. As limited companies pay corporation tax rather than income tax on any profits, finance costs can be fully offset against rental income. The rate of corporation tax is also gradually dropping from 20% to 17% by April 2020. Serious consideration has to be given however to the extra costs associated with running a limited company, as well as any further taxation for investors taking money out of the company when required. Properties already owned can be transferred into limited companies, but there are serious implications with regards to further Stamp Duty / LBTT and Capital Gains Tax if an individual was to do so.
Advice really needs to be sought before embarking on such solutions to ensure they are appropriate for your circumstances and objectives.
If worst comes to worst and a particular property is no longer viable to hold from a tax perspective, the sale needs to be managed carefully to ensure all allowances and reliefs are used to minimize tax. Measures are available which allow investors to defer tax payable on property capital gains, which could also be explored to reduce the effect.
For more information / advice on the above, or any other areas of financial planning, Phil can be contacted on 0131 226 7193 or via email at [email protected]. You can also learn more about Reddington Wealth Management Ltd on their website, www.rhwml.co.uk .