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Updates from the Clayton & Brewill team.
Tax changes to hit small and accidental landlords hard
In the Summer Budget, the Chancellor announced that tax relief on buy to let finance costs will be reduced to 20%, meaning that many landlords will see their tax bills leap.
Clayton & Brewill's Doug Perry and Dan Burnell explain the changes, including the removal of the wear & tear allowance.
Doug Perry
At the moment, buy to let landlords can classify finance costs on their properties as a business expense, and offset it against tax. These finance costs mostly relate to mortgage interest, but can also include mortgage arrangement fees, and finance on loans to buy furnishings.
However, under the forthcoming changes, landlords will no longer be able to include finance costs as a business expense. Instead, the landlord will be able to claim 20% tax relief on these costs against their income tax liability.
Importantly, this relief stays at 20% regardless of whether or not the individual is a higher rate tax payer – meaning that anyone paying income tax at 40% or more will see their tax bill rise considerably.
(Note that these proposed changes do not include furnished holiday lets.)
How the tax change will affect landlords in practice
Here is an example of how the tax position will change when the new rules are fully in place for the 2020/21 tax year.
Nick and Ella are higher rate tax payers and they each own a property. They live in Ella's house and rent out Nick's apartment.
They earn an annual rental income from the flat of £12,000 and pay £6,000 in mortgage interest.
Nick and Ella also incur around £1,000 of costs – letting agent fees, repairs and so forth.
Under the current scheme, this means that they make a profit of £5,000 – the rental income less the costs incurred in renting out the flat, namely the interest and the other expenses.
As a 40% taxpayer, this gives Nick a tax liability of £2,000.
Under the new scheme, only the expenses – eg the letting agent fee and the repairs – can be offset against the rental income. Nick can no longer count the mortgage interest as a business expense.
This makes his profit £11,000 and creates a much higher tax liability of £4,400. Nick can offset this with the new tax relief of 20% on the mortgage interest.
Based on the annual mortgage interest amount of £6,000, this will give £1,200 of tax relief, meaning Nick's total tax liability will be £3,200.
So, in this example, the new tax rules will see Nick and Ella's tax liability jump from £2,000 to £3,200 – effectively a whole month's rent.
The impact of the changes will be felt even more keenly if finance costs rise, as they are predicted to do in many quarters.
A phased approach means time to plan
The only chink of good news is that this is being phased in over a three-year period from April 2017, and the full impact won't be felt until the 2020/21 tax year, giving you time to plan.
For some landlords it may make sense to move your property/properties into a company structure, although this of course brings capital gains into the equation and will depend on long term plans with the property/properties and your personal situation.
The best approach is to talk to your accountant (such as one of the friendly buy to let specialists at Clayton & Brewill!) who will crunch the numbers for you and give you advice on how to maximise your tax position.
Removal of the 10% wear & tear allowance
Dan Burnell
Another important change and one that comes into play in April 2016, is the removal of the 10% wear & tear allowance. This currently allows landlords to deduct 10% from their rental profit – regardless of how much they had actually spent on repairing or replacing the furnishings.
From 6 April 2016, landlords will only be able to deduct the actual costs they had incurred.
This would seem like a fair change but it will make record keeping essential – as a landlord you will need to keep a careful record of your expenditure on repairing and replacing furnishings in order to be able to deduct the costs from your taxable income.
At Clayton & Brewill we work with a large number of landlords, from single property owners through to buy to let landlords with large portfolios. For help your tax position, please contact us on 0115 950 3044 or click here to send us an email.