The most punitive change in the tax rules for individual landlords has been the restriction of mortgage interest relief. Now that restriction is really starting to bite, Jerome Lane considers the tax implications and possible opportunities.
Since 6 April 2017, all mortgage interest and similar finance costs have been restricted as a tax deduction for all individual landlords who let residential property. From 6 April 2020, no finance costs will be allowed as a gross deduction. Instead, an income tax reducer will be given against the individual’s tax liability. The reducer is calculated as the lower of:
• 20% of the prescribed finance costs not already deducted from property income;
• the property business profits; or
• total income (except income derived from investments) that exceeds the personal and blind persons’ allowance.
These rules are being phased in over three tax years by providing that only a percentage of finance costs will be allowed as a deduction from gross property income. For 2017/18 only 75% of finance costs were deductible, for 2018/19 the allowable costs were 50%, for 2019/20 the allowable costs will be 25%, and for 2020/21 no deduction will be allowable.
How relief is given
Tax relief is applied in the form of a 20% deduction of finance costs from taxable income, as follows:
• For 2017/18 20% of the 25% of finance costs
• For 2018/19 20% of the 50% of finance costs
• For 2019/20 20% of 75% of finance costs
• For 2020/21 20% of 100% of finance costs
The restriction of mortgage relief could push effective tax rates on property income to well over 50% by the year 2021 for landlords who are heavily geared and are (or become) higher rate taxpayers as a result of how the restriction applies.
Therefore, it would be prudent for all landlords to understand their exposure and consider tax planning steps to maximise profitability and ensure the future of their property business.
Many landlords believe it is too late to act and are considering selling up their portfolios at capital gains tax rates of up to 28%.
Tax planning opportunities
Whilst the new rules affect all landlords with outstanding finance obligations, larger unincorporated property businesses and those reinvesting profits into further acquisitions are likely to feel the pain more. However, property tax planning can have significant capital gains tax (CGT) and stamp duty land tax (SDLT) implications.
Other more practical issues include the potential need to rearrange finance arrangements and legal documents, including land registry records and tenancy agreements. The whole process can be costly and very time-consuming.
Many landlords are hesitant due to the high potential tax exposure and differing views as to what is feasible. Property is largely an unregulated area which can lead to a lack of clarity when it comes to tax and legal issues.
Incorporation
The mortgage interest relief restriction has already driven many landlords to incorporated their property businesses. However, they need to be advised of the traps, pitfalls and potential risks.
CGT relief
There have been many tax cases that challenge whether the property business qualifies as a business for incorporation relief to apply where property has been transferred to a company, so the gain can be rolled over into the share value.
The most prominent case which went in the taxpayers’ favour is Elizabeth Moyne Ramsay v HMRC [2013] UKUT 0226 (TCC). This case has served as a benchmark in considering whether a business exists for incorporation of its property business.
SDLT relief
It is also possible to seek a pre-transaction clearance from the stamp office, where it is considered that the SDLT charge on the transfer of the properties should be nil. This will generally only apply where the business being transferred has been carried on in partnership between individuals who are connected to each other, such as father and son.
Other considerations
Where a property enterprise serves as a lifestyle business, incorporation may not be suitable due to the double taxation of income for the company and then on the shareholders or directors when the income is extracted from the company.
Where landlords are considering restructuring their portfolios, since properties are deemed to be acquired at market value by the company, disposals post-incorporation could be made without significant corporate gains releasing more funds for further investment.
There is always the possibility that legislation could be changed in the future to amend the tax treatment of investment companies, or the corporate finance rules for property businesses could result in companies being afforded similar treatment on interest payments to individual landlords.
The much-publicised potential introduction of an £80,000 basic rate band recently suggested by the Prime Minister could once again level the playing field.
Landlords should, therefore, be wary of incorporating solely to mitigate income tax and take a holistic approach to the pros and cons of operating via a corporate structure.
Conclusion
Any landlord considering the incorporation of their property business should take full tax advice on the suitability of such arrangements in their particular circumstances. It is possible to seek HMRC clearances to give you certainty that it will not challenge transactions carried out as described to them. (1)
[1] Reproduced from AccountingWeb