02 Mar Ways to reduce the impact of tightening buy-to-let tax rules
Ways to reduce the impact of tightening buy-to-let tax rules
As you are aware, the buy-to-let market has been bracing itself following successive moves by the government to add an additional 3% to stamp duty followed by restricting tax relief on buy-to-let mortgage interest payments.
Having said that, there are still ways which you can minimise the impact of the above changes.
We will look at what is changing, and ways you can take so that you are not left out of pocket.
What are the changes?
With effect from 1 April 2017, a restriction will come into place on claiming higher rate tax relief on mortgage interest payments on residential property.
This means that the tax relief on ‘finance costs’, the interest on loans to buy furnishings and mortgage interest will be restricted to the basic rate of tax.
This will be phased in over the next four years and by 2020, the phased in tax relief reduction will be fully in place. This will eventually have a significant change in the profitability of mortgage/debt funded buy-to let portfolios.
Say you are a higher-rate taxpayer earning £22,000 per year rental income and your mortgage interest costs £12,000 per year. Tax is due on the profit (£10,000), so you pay £4,000 to HMRC and keep £6,000 as profit.
By 2020 (when the phased in tax relief reduction is fully in place)
40% tax will be due on your full rental income (£22,000) which will be £8,800. From this you can claim a 20% tax relief on the mortgage interest (20% of £12,000) which is £2,400. This means you will need to pay £6,400 to HMRC and keep £3,600 as profit. Therefore, your tax bill has increased by 60%.
Ultimately, the higher the interest you pay, the more you will be impacted. Therefore, if you have a long-term fixed rate (usually offered at a higher rate) you may find your profits are in danger of being wiped out.
So, how to minimise the effect of these tightening tax rules?
Well the simple way is to increase the rents to cover your lost rental income, but these can be difficult in reality when factoring in the local rental market rates or goodwill with your tenants.
However, there are four other ways that could help you to minimise the exposure to these changes:
• A Company Structure – you can place your property portfolio in a limited company structure as the buy-to-let property held in companies are not affected by this new changes. You will then pay Company tax on the profits, which will be lower. However, there are advantages and disadvantages to consider and in particular the potential tax consequences of incorporating the business into a company. A professional advice should be sought before making a decision.
• Review your mortgage – speak to your mortgage advisor to see if you can get a better deal such as short-term fixed rate which will offer lower interest rates. But again, there is risk if the base rate of interest increases in the near future.
• Claim relief on repairs and maintenance – ensure that you are claiming your reliefs on repairs that you carry on your properties. An experienced tax advisor will be able to identify exactly what you can claim and what you can’t claim and this is very important. Proper record keeping is also essential to ensure you have supporting documents to support your claim.
• Transferring ownership – If case your spouse pays a lower rate of tax, you can transfer ownership of your property to them. However, this should be reviewed to ensure it doesn’t put them into a higher tax band.