Two important tax reliefs
At present, in working out the amount of profit liable to tax on a residential buy-to-let
- If the property is let fully furnished, you cannot deduct the cost of buying or replacing furniture – instead a special deduction equal to 10% of the rent is given, which in most cases is much more beneficial
- All the interest (but not capital) on any loan taken out to buy, improve or maintain the property is fully deductible
What are the changes?
The first change is that from April 2016 the special 10% deduction is abolished. Instead you will get tax relief for the actual costs of replacing furniture. This is likely to increase somewhat the tax payable on furnished lettings.
The second change is likely to be much more damaging for a large number of owners. Instead of being allowed to deduct the full amount of loan interest, owners will get relief only at the basic rate of tax. The change applies only for Income Tax purposes (so doesn’t affect companies). Although it will not be fully effective until April 2020 it starts to be phased in from April 2017 and you should start planning for the change now. If you own buy-to-let property free of debt (or if you own through a company) the change will not, of course, affect you at all.
What difference will it make to me?
- Your rental income from letting unfurnished property (after deducting all expenses other than interest) amounts to £40,000.
- You pay interest of £30,000.
- You have other income which absorbs your personal allowances and basic rate band
Then at present you will be paying Income Tax of £4,000 on your profit of £10,000. Even assuming that interest rates remain unchanged, when the new rules come into full force your Income Tax bill will be £10,000. In other words, your tax rate will increase to 100%!
In fact, it is very easy to envisage circumstances in which the tax rate may exceed 100%: the tax that you pay may exceed the commercial profit which you make from the letting. This would be the case, for example, if
- You are liable to tax at 45% instead of 40% or
- Interest rates increase faster than rents
What can I do?
We think that there are a number of options. None is ideal.
- Do nothing: accept that the investment has a much reduced running yield (or even a negative yield) and rely upon capital growth for your profit.
- Find funds to repay the loan, either by selling assets or possibly in appropriate circumstances by re-financing other assets.
- Sell the property. If you want to continue to invest in the property sector you could then consider
- Investing in commercial property (where the new rules do not apply);
- Investing via a company;
- Investing jointly with others in debt-free residential property; or
- Investing in a managed residential property fund
- Sell the whole or part of your interest in the buy-to-let property to a company which you control, on terms that the company takes on the whole of the borrowing.
Each of these options has its own tax consequences and there will be wider commercial issues to consider as well. Every case is likely to be slightly different, but among other things you may need to consider the impact of
- Capital Gains Tax both now and when the property is sold in the future
- Stamp Duty Land Tax
- Dividend Tax
- Inheritance Tax
For further details please contact your usual BKL relationship manager or use our enquiry form.