The topic of conversation amongst property investors right now is the change to rules around buy to let income, due to start in 2017. These impending changes will affect all rental investors to varying degrees, depending on the tax bracket they fall into. If you’re a property investor or considering buy to let, you firstly need to understand how you will be affected before looking at the options for reducing your tax bill.
Let us pretend that annual rent received on an investment property is £10,000 and you have a mortgage secured against this property which costs you £8000 in interest per year. In previous years you would have to pay tax, at your nominal rate, on the profit, in this case £2000.
- Low rate tax payer would pay 20% of £2000 = £400 tax
- Higher rate tax payer would pay 40% of £2000 = £800 tax
- Additional rate tax payer would pay 45% of £2000 = £900 tax
The new rules, coming into effect in April 2017 will remove the ability to deduct the annual cost of the mortgage interest in full and instead will only allow a 20% to be offset as a tax credit. Based on the above figures this will mean you would be able to deduct £1600 (20% of the £8000 cost) from your annual rental income before you calculate profit. Let’s see what the tax will be when these changes come into full effect.
- Low rate tax payer would pay 20% of £8400 profit = £1,680 tax
- Higher rate tax payers would pay 40% of £8400 profit = £3,360 tax
- Additional rate tax payers would pay 45% of £8400 profit = £3,780 tax
It is clear that this tax change and the increased Stamp duty land tax will make a considerable difference to any profit made.
There is, however, some good news. Firstly, the change will be phased in over four years, starting in the 2017-18 tax year, when 25% of finance costs will be subject to the new rules. This grows to 50% in the 2018-19 tax year, 75% in 2019-20 and from the 2020 tax year onwards these rules will apply to all finance costs. So you do have some time to adjust to the changes.
There are some options that I am now helping my clients to explore.
The first and most simple one is to review your mortgage arrangements. You may find your current rate isn’t the best available to you so there could be some potential savings there.
Some clients are setting up limited companies and purchasing rental properties through these companies. There are a several mortgage lenders that are happy to lend to Ltd companies. Currently the new rules coming into force are not applied to properties held within Ltd companies but corporation tax will be charged. Be careful if you are transferring an asset as this would constitute a disposal and Capital Gains Tax (CGT) would be due. Another option is to transfer a property to a low tax paying spouse or other family member, but again be careful of CGT rules and also consider whether the rental income will change the tax bracket for the new owner.
As always it’s worth taking advice from a specialist who knows the rules, the market and can explain your options.