What are the future changes that landlords will face post stamp duty tax hike?
It came as no surprise that there was a record number of Stamp Duty Land Tax (SDLT) receipts earlier this year as buy- to-let landlords rushed to beat the deadline for increases in SDLT introduced on 1 April 2016.
However, increased SDLT costs on the purchase of additional residential properties is not the only nasty surprise in store for residential property investors.
In March, the Bank of England announced its proposals for much tougher buy-to-let mortgage lending criteria. The rules will require lenders to carry out stricter “stress tests” on prospective borrowers or those wishing to re-mortgage to ensure that they have sufficient capital to cover repayments if interest rates increase to 5.5%.
Tax relief for finance costs
In the future, there will also be changes to the way that tax relief for interest payments on the purchase of residential lettings will be given in the tax computation. This will affect individuals, partnerships and limited liability partnerships which let out residential properties. At present there are no proposals for this restriction to apply to furnished holiday lettings nor to companies with residential lettings.
Currently, rental profits are reduced by any loan interest paid and therefore a top rate taxpayer could receive tax relief at 45% on their finance costs. Under new legislation the loan finance costs will be relieved by way of a reduction of the tax liability, rather than a reduction in the rental profits, and is restricted to relief at the basic rate of income tax. Those with substantial rents and interest costs, thus with low net profits, who are currently basic rate taxpayers, could see their income pushed into the higher rate band as the interest costs will be added back to the rental income.
For example, an individual whose only income is rents of £50,000 and interest costs of £20,000 would have net income of £30,000, and so within the basic rate tax band. Under the new rules the same individual would be a higher rate taxpayer because their income would be £50,000 with a deduction for interest relief given at the basic rate only.
As a result of the way in which the net rent will be calculated those whose income is close to the £50,000 threshold for the withdrawal of child benefit, and those with income near £100,000 for the withdrawal of personal allowance could be adversely affected even though their income has not actually increased.
To “soften the blow” these measures will be phased in gradually over four years and will apply to 25% of the interest costs in the 2017-18 tax year, 50% in the 2018-19 tax year and 75% in the 2019-20 tax year before being implemented in full in the year to April 2021.
If you have a relatively modest portfolio of properties which are let out as residential lettings, it maybe that you will simply have to accept that your income tax liability in respect of those lettings may increase in future as taking any steps to mitigate the interest restriction could be costly. Sharing income with family members or family trusts may be worth considering but capital gains tax issues will need to be addressed.
Incorporating your business
If you have a substantial portfolio of residential lets you may wish to consider incorporating your business, however, there could be a substantial capital gains tax liability if you incorporate your property portfolio because moving the properties into a company could trigger capital gains tax. However, if you have a large property portfolio that you devote a substantial amount of time to managing, it may be possible to claim capital gains tax roll-over relief on incorporation of a business to mitigate the capital gains tax liability arising. If you have no gains in your property portfolio it may be possible to transfer the properties into a company without triggering capital gains tax.
However, there is likely to be a substantial SDLT liability on the property transfers to a company, unless specific reliefs are available, and incorporation of a property business should not be undertaken without specialist advice.
It would be necessary to weigh the costs of incorporating an existing property business, including administering a company, against the additional cost of the new interest rules. Also the new “stress test” rules could see the cost of your borrowings increase.
The residential property investor is entering a whole new world and it remains to be seen if George Osborne’s efforts to help first time buyers onto the property ladder, which is a laudable aim in itself, are helped or hindered by the various measures he has introduced.