Changes are on the horizon for buy-to-let property owners. It is important to understand these. Separately, the interest on any mortgage or loan taken to buy, improve or maintain the property, is fully deductible.
Currently, available to all landlords with a fully furnished buy-to-let property is a”wear and tear” allowance, where 10% of the rental income can be deducted from the rental profits for tax relief. This allowance requires no evidence of spending, it is simply a calculation at the end of the tax year.
Changes to claiming for wear and tear
From April 2016, the 10% wear and tear deduction will be abolished. Instead, tax relief will be available for the actual costs of replacing furniture, which is likely to affect the tax payable on furnished lettings, as the current 10% Wear and Tear Allowance is considered generous.
Changes to claiming mortgage interest tax relief
More importantly, the second change is likely to be much more damaging for many property investors.
Instead of being able to deduct the full amount of loan interest, owners will get tax relief at the basic rate of tax of 20% only. This change in legislation will affect higher rate tax payers, and a handful of basic rate tax payers that may get pushed into higher rate tax in the process.
It will also only apply to income tax so limited companies will be exempt from any changes.
Although the new proposed system will not be fully effective until April 2020, it starts to be phased-in from April 2017. Buy-to-let property landlords should start planning for the change now.
What are your options?
The proposed changes could be significant for a higher-rate tax payer and in some cases, the tax payable in 2020 will be 150% of what it is now.
There are a number of options for consideration:
- Do nothing: accept the increased liability and rely upon capital growth for your profit
- Increase rents: many landlords are making, or planning to make, adjustments to their rent price to cover the loss of profits from additional tax.
- Repay the loan: property holders without a mortgage are unaffected by the changes, so an option is to find funds to repay the remaining mortgage.
- Sell the property: and look to reinvest elsewhere
- Invest differently: If you want to continue to invest in the property sector you could consider:
- Investing in commercial property (where the new rules do not apply);
- Investing via a company, taking care of stamp duty and capital gains tax
- 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
It may be possible to ignore these changes for a couple of years, but it’s a ticking time bomb.
Don’t run the risk of waiting too long to make a plan and start to protect the future of your investment portfolio.
Now is the time to start planning.