TAXATION CHANGES FOR BUY-TO-LET LANDLORDS

Over the course of the past year or so, HM Revenue & Customs have announced various changes to the taxation of rental income which will have an unfavourable impact on most landlords. With so many changes in this area, together with various different dates of implementation, it is worth recapping on the recent changes and detailing how these might affect landlords over the coming months and years.

MORTGAGE INTEREST

Under the current rules, in calculating their taxable profit from receiving rental income, landlords can deduct the full amount of any interest that they pay on a mortgage taken out for the purpose of the property letting business.

Changes were announced in the 2015 Summer Budget that will restrict the amount of tax relief available on mortgage interest and associated finance costs e.g. arrangement fees (hereinafter referred to as ‘interest’) to the basic rate of tax only. Landlords who are higher rate taxpayers are currently able to obtain 40% tax relief on such interest (45% for additional rate taxpayers) but under the new rules this will be restricted to 20% only.

These changes are being introduced from 6 April 2017 and are being phased in over the four tax years from 2017/18 to 2020/21. Currently the interest paid is treated as an expense and deducted from the rental income received. The new basic rate relief will be achieved by treating the interest costs as a tax reducer. In 2017/18, 75% of the interest will be allowed as a deduction against the rental income with the balance of 25% only obtaining tax relief at 20%. By 2020/21, 100% of the interest will only obtain tax relief at 20%.

Taxpayers could be forgiven for assuming that this change will therefore only affect higher or additional rate taxpayers but it is important to note that, due to the mechanism of these changes as mentioned above (whereby the interest will no longer be deducted from income) it can mean that some basic rate taxpayers are pushed into the higher rate bracket, even though a landlord’s incomings and outgoings may be the same year on year. For example, if a landlord pays £5,000 of mortgage interest on his let property in 2017/18, only £3,750 of that interest will be allowed as a deduction from his rental income in that year, with a deduction of 20% of the remaining £1,250 i.e. £250 being available as a deduction against the final tax liability for the year. This means that the landlord’s taxable income for that year will be £1,250 higher than it would otherwise have been, which may be sufficient to push his taxable income into the higher tax bracket. By 2020/21 taxable income will be £5,000 higher as a result of the changes.

REPLACEMENT OF DOMESTIC ITEMS RELIEF

This change is particularly important to landlords of furnished rental property who, prior to 6 April 2016, were entitled to claim a fixed deduction each tax year usually based on 10% of the rental income, commonly known as the ‘wear and tear’ allowance.

With effect from 6 April 2016, the ‘wear and tear’ allowance has been replaced with the new ‘replacement of domestic items relief’ which allows landlords of any type of residential property, whether let furnished, unfurnished or partly furnished, to deduct the actual costs of replacing furniture, furnishings, appliances and kitchenware provided for the tenant’s use. The original cost of such items does not qualify for tax relief. This change does not apply to qualifying furnished holiday lets.

The impact on landlords will vary depending on whether they let out their properties with furnishings or not, but those who are used to claiming the 10% ‘wear and tear’ allowance each year may see an increase in their tax liability for 2016/17 onwards if they do not incur much in the way of expenditure on replacing furniture and furnishings etc.

These changes are however welcome news for some landlords of unfurnished or partly furnished properties since such landlords have not been able to claim tax relief on this type of expenditure since the rules changed in April 2013.

STAMP DUTY LAND TAX (SDLT)

 With effect from 6 April 2016, most individuals who acquire a residential property in addition to either their main residence or other existing buy-to-let properties will have to pay an additional 3% SDLT on the cost of that property being acquired and this operates by way of increasing the normal SDLT rates by 3% across the board.

The rules are complex (particularly, for example, for joint owners of property and spouses/civil partners) but suffice to say, this could have a significant impact on prospective landlords or existing landlords looking to acquire further buy-to-let properties

CAPITAL GAINS TAX RATES (CGT)

A reduction in the rates of CGT was unexpectedly announced in the March 2016 Budget, with the basic rate being cut from 18% to 10% and the higher rate cut from 28% to 20% with effect from 6 April 2016. However, this does not apply to residential property and therefore both buy-to-let and second home owners will essentially face an 8% surcharge on tax paid on the gains on the sale of such property. Note also that it is proposed that with effect from 6 April 2019 payments on account of CGT on the disposal of residential property will be due within 30 days of the date of sale. Currently sellers have anything between ten and twenty-two months to pay.

Some of the issues surrounding the above changes are complex and landlords (or prospective landlords) will need to consider the effect on their tax affairs. Specific advice will need to be sought in the majority of cases and we would be pleased to assist with any queries you may have or to review your tax position generally in light of these changes.

The above is for general guidance only and no action should be taken without obtaining specific advice.