In last months Budget, the Chancellor announced that mortgage interest payments and arrangement fees incurred when taking out buy to let mortgages for residential properties will be restricted to the basic rate of tax, currently 20%. This change in practice will be phased in over four years from April 2017.
Under current rules a 45% taxpayer with an annual rental income of £10,000 and annual mortgage interest of £6,000 would receive a tax bill on the rental profit of £1,800. This tax bill could eventually rise to as much as £3,200 under the new rules. In other words the tax relief on the £6,000 interest would fall from £2,700 to £1,200. For a 40% tax payer the relief would fall from £2,400 to £1,200.
What strategies might affected investors in residential property consider to mitigate the higher liabilities ?
There are two basic strategies other than selling up:
Landlords might consider allocating rental income to spouses on lower tax bands by transferring the beneficial ownership of property. This strategy does, of course, involve issues other than tax and it depends on personal circumstances …. and the formalities of a spousal gift must be complied with to be effective.
Alternatively, landlords may take a longer term perspective and consider incorporating their letting business. Companies are not affected by the new rules – any interest payment would qualify as a business expense and, therefore, qualify for tax relief. While it is true that the rate of tax relief is comparable for individuals under the new regime and the corporate regime, the net rental income is taxed at the much lower corporation tax rates.
In addition, the prospective tax changes will for once operate in favour of corporate investors as the rate of corporation tax is due to fall from 20% to 19% from April 2017 and to 18% from April 2020 – which, if profits are to be retained within the company, would represent a significant tax saving for a higher rate tax payer.
While that all sounds ideal there are plenty of obstacles to overcome and incorporation is not a route to be taken lightly.
Transferring existing property into a limited company may incur capital gains tax and stamp duty land tax liabilities and investors should be familiar the recent tax case of Elizabeth Moyne Ramsey v HMRC [2013] UKUT 266 TC in this context. Incorporation will favour those with several properties in their portfolio.
Landlords should also be aware that unless they have a proven track record, high street lenders may not consider lending to a limited company. There are specialist finance providers that will lend but their arrangement fees and interest are higher, and again, they only tend to lend to established landlords with a proven track record and multiple properties.
Nevertheless, it should be remembered that mortgages which allow limited companies to be borrowers currently comprise 13% of all such products on the buy to let market and this figure can be expected to increase as a direct consequence of the budget. Even if the mortgage costs for limited companies are above the rest of the market, these could come down as demand grows and lending to companies becomes more competitive.
Any strategy for holding investment property should also consider the potential exposure to inheritance tax … and there are inheritance tax advantages to holding property through a company. The spectre of inheritance tax is a real blind spot for property investors and their advisers ….. which is very surprising given the astronomical sums of tax at stake. I have yet to see the family which is not bitterly disappointed with their legacy where this issue has been left to chance or fudged in the landlords lifetime. A property portfolio may have been fantastically managed during a landlords lifetime but the absence of any tax efficient succession plan usually presents a devastating blow to family wealth.
I will be publishing a book before the end of the year on what can be done for those who wish to be in control of this pressing issue … so stay tuned.
