There have been a number of recent changes to the tax system which impact on individuals with residential lettings. Some of these came into force from April 2016 and further changes are occurring from April 2017.
The 10% wear and tear allowance has already be removed and substituted by a replacement furniture relief from April 6 2016, which as its name suggests, allows relief on the replacement of certain furniture and goods but not the original cost.
From April 6 2016 there was also a 3% surcharge on Stamp Duty Land Tax rates on purchases of additional residential properties, where there has not been a replacement of the main residence.
Restriction on Finance Costs
Perhaps the most significant of these changes, which is being phased in from April 2017, is the restriction on tax relief for finance costs.
Previously, finance costs (e.g. mortgage interest) would be included as an expense and deducted from rental income in arriving at the taxable profit of your lettings business. Accordingly this meant you would be receiving tax relief at the highest rate of tax you pay.
By April 2020, rental profits will be computed without deducting mortgage interest, with landlords entitled to a 20% deduction for mortgage interest paid instead (known as a tax reducer). This will not make a difference for basic rate taxpayers but higher rate taxpayers with mortgages on their let properties will face higher tax bills.
Transitional rules apply from 2017/18 to phase the rules in over a four year period.
Should I Incorporate my Property Business?
For those affected by the restriction, many are considering owning properties via a company, as the restriction on finance costs does not apply to companies. Corporation tax rates are also favourable to income tax rates; from April 2017 companies will pay 19% corporation tax on their profits compared to the highest rate of income tax of 45%.
However there are points to consider before deciding to transfer existing rental properties into a company, which include the administration costs of running a company, the cost of renegotiating buy-to-let mortgages, arrangement fees, solicitor fees etc.
From a tax perspective there are two main problems. Firstly, transferring a property to a company is a disposal for capital gains tax purposes and this will give rise to a capital gain based on the market value of the property on transfer. The capital gains tax rates for residential properties remain at 18% for basic rate payers and 28% for higher rate payers. In certain circumstances it may be possible to claim “incorporation relief” which will mean that the gain would not come into charge, but the relief is not available in all situations and professional advice should be sought.
The second consideration when incorporating is Stamp Duty Land Tax, which applies when a residential property is transferred from a connected person into a company and the charge is based on the market value of the property.
There is an exemption from SDLT if it can be demonstrated that the properties were transferred from a partnership to a company, but this will be rarely available.
Because of the potential capital gains tax and Stamp Duty Land Tax charges in many cases incorporation will not be viable and it is important that proper advice is taken. It may well, however, be worth considering the acquisition of new residential properties within a company structure.
Making Tax Digital (MTD)
Finally, a word of warning. Landlords will soon be required to submit details of their income on a quarterly basis and in electronic format. For some this requirement could begin as early as April 2018 so landlords should take advice on this sooner rather than later.
The tax issues surrounding property ownership are now more complex than ever so it is important that you speak to your accountant or tax adviser if you are considering any changes.