tax
FEBRUARY 2016
www.pkffpm.com
a tax supplement from pkffpm accountants
Bye, Bye, Buy-to-let?
By
Paddy Harty
SeniorTax Director
[email protected]
The arrival of the
buy-to-let (BTL)
mortgage product in
the mid 1990s allied
with ‘interest only’ deals,
spawned a new generation
of landlords. Investors
clamoured into the property
market often seeing this
asset class as an alternative
to traditional retirement
saving.
The inevitable happened,
residential property prices soared,
development land rocketed in
price and following the Lehman
Brothers collapse and the ensuing
financial crisis, property slumped.
When the music stopped, far too
many BTL investors were left in
terrible negative equity situations
and many remain so to this day,
desperately hoping for a price
recovery and surviving because
they have an interest only
mortgage and can set all of the
interest off against rental income.
At least they don’t have a tax bill
to pay on the rents, however all is
set to change from April 2016.
In his Summer Budget, the
Chancellor announced two
adverse tax measures for BTL
investors. The first is the removal
of the 10% wear & tear allowance
for furnished lettings commencing
April 2016 and the second is a
restriction on tax relief on interest
paid on BTL debt to the basic
rate of income tax which will be
phased in over 4 years starting
in April 2017. Furthermore in
his 2015 Autumn statement he
announced an increase in Stamp
Duty payable on second homes.
The Wear & Tear
allowance
The 10% wear and tear allowance
will be replaced with a relief that
enables all landlords to deduct
the costs of replacing furnishings
in the property however the initial
cost of furnishing will not be
allowed.
Under the new rules the
relief will cover the capital cost
of replacing items in a furnished
BTL including inter alia, carpets
& curtains, moveable furniture,
electrical appliances and crockery
& cutlery.
Integral features however
such as fitted kitchens, boilers,
baths etc. are excluded as their
replacement will continue to be a
deductible expense as a ‘repair’
on a like-for-like basis.
The change in the Wear & Tear
allowance will apply from April
2016
It will not apply to furnished
holiday letting businesses and
letting of commercial properties,
because these businesses
receive relief through the capital
allowances regime.
Restricting finance
cost relief
The restriction of finance cost
relief for residential landlords
to the basic rate of income tax
will be phased in over 4 years
commencing in April 2017.
The term ‘finance costs’ refers
to interest and the incidental costs
of obtaining or repaying loans
TABLE A
2015/16
Salary
£40,000
Rent Account
Rent
£16,800
Interest
(£10,000)
Expenses
(£5,250)
W&T
(£1,680)
Rental Profit/(loss)
(£120)
Taxable Income
£40,000
11,000 @ 0%
0
29,000/32,000 @ 20%
£5,880
8,550 @ 40%
-
Income tax reducer - £10,000 x 20%
-
Child benefit recovery charge
-
Total
£5,880
2020/21
£40,000
£16,800
(£5,250)
£11,550
£51,550
0
£6,400
£3,420
(£2,000)
£388
£8,208
such as arrangement fees.
The restriction only applies to
amounts borrowed for the purpose
of generating income from land
consisting of a dwelling-house and
excludes borrowings for property
development trades or borrowings
for trades that are secured on a
let dwelling-house.
Furnished holiday lets are
excluded however overseas
residential property is included.
The restriction only applies for
income tax purposes and applies
to individuals, partnerships and
trusts however importantly, the
restriction does not apply to
companies.
The way in which the restriction
operates is likely to cause BTL
investors the biggest issue in
that finance costs will no longer
be given as a deduction from
property income, instead a basic
rate reduction will be given thus
potentially affecting investors
with income nearing £50,000
and those with income nearing
£100,000 as they stand to lose
their child benefit (£50k) and
personal allowance (£100k).
The examples overleaf highlight
how the impact of the restriction
is far more wide ranging as the
measure also re-defines the
computation of rental profit via the
way in which the basic rate relief
is given.
Example 1 – Robert
Robert is a manager for a
supermarket chain. His gross
salary is £40,000. His only other
>>
Whilst every care has been taken to ensure the accuracy and contents of this publication, the information is intended for general guidance only.
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25
YEARS
1991- 2016
2
<<
income is rental income from
2 buy-to-let properties that he
acquired on 100% interest only
mortgages for £200k each @
2.5% before he married his
wife Maureen who doesn’t work
and looks after their 3 small
children. The gross rents from
the properties are £16,800,
expenses are £5,250 per annum,
wear & Tear is @10% (£1,680).
Robert heard about the interest
relief restriction but isn’t worried
because it won’t affect him, he’s
making an annual loss on the
property rental and he’s a basic
rate taxpayer so it has no effect
on him, or does it?
SEE TABLE A
Robert now has an extra
£2,328 of tax to pay as a result
of the change in tax legislation.
Furthermore where is he going
to get the money to pay this bill?
He only has a cash surplus of
£1,550 from his lettings.
The cost is even more
significant for taxpayers on the
verge of exceeding taxable
income of £100,000 as they
will start losing their personal
allowance moving move profit
into higher rate tax.
Example 2 - Jimmy
Jimmy earns £95,000 per annum.
He has 6 BTL properties which
cost £1.5m, yield rent of £50k
PA, repairs are £7.5k PA, Wear
& Tear is £5k and interest costs
are £37.5k PA. He is concerned
about the interest restriction
changes and loss of wear and
tear and thinks it will cost him
£9,500 PA (ie, £5k W&T @ 40%
plus 20% x £37.5k).
However a detailed
computation reveals the
following: SEE TABLE B
Jimmy’s tax has actually
increased by £13,740 due to:
• Loss of tax relief on wear & tear - £5,000 x 40% = £2,000
• Loss of higher rate tax relief on
interest - £37,500 x 20% = £7,500
• Loss of personal allowance - £10,600 x 40% = £4,240
25
YEARS
1991- 2016
The manner in which the
interest relief restriction is applied
can therefore have more tax
impact than the restriction itself.
Incorporation?
When the dust had settled on
the Summer Budget the knee
jerk reaction was to incorporate
residential property letting
businesses. Highly leveraged
portfolios will not be easily
re-mortgaged in the current
banking environment particularly
as many are in negative equity
and the days of 90% BTL
mortgages are long gone with
lenders now typically requiring
40% equity.
Landlords fortunate enough
to have a mix of residential and
commercial borrowings may be
able to restructure and shift the
majority of their borrowings onto
the commercial portfolio.
Incorporation may be a
viable option for some landlords
however having overcome
the costs of re-financing their
portfolio inside a corporate they
will have a double tax charge
with corporation tax on the rental
profit and income tax on profit
extraction especially as the new
dividend tax regime comes into
force in April 2016. Some may
prefer to let the net of corporation
tax profits accumulate and hope
that the rumours of the return
of the dreaded ‘Close company
apportionment surcharge’ do not
materialise!.
Incorporation has also to
be weighted up against the
Capital Gain Tax cost of selling
properties into a company
however if the property business
is actively managed it may to
be possible to have it treated
as a ‘business’ and secure
CGT incorporation relief on the
movement of the properties into
the company by deferring the
CGT via rollover into the base
cost of the shares.
Stamp Duty
The final hurdle on incorporation
is Stamp Duty. The acquisition of
the properties by the company
will result in a stamp duty liability
however multiple dwellings relief
may be available – this can
reduce the stamp duty cost by
permitting an averaging method
to be applied across a portfolio’s
value rather than stamping each
property on its individual value.
The Autumn Statement
however will add 3 percentage
points to the rate of stamp duty
paid by those who already own
property from April 2016.
As a result, the tax bill on
a buy-to-let property costing
£150,000 will jump tenfold from
£500 to £5,000.
TABLE B
2015/16
Salary
£95,000
Rent Account
Rent
£50,000
Interest
(£37,500)
Expenses
(£7,500)
W&T
(£5,000)
Rental Profit/(loss)
nil
Taxable Income
£95,000
10,600 @ 0%
0
31,785 @ 20%
£6,357
52,615/105,715 @ 40%
£21,046
Income tax reducer - £37,500 x 20%
-
Total
£27,403
2020/21
New buy-to-let stamp
duty: How much will
you pay?
Value of second property/BTL (£) SDLT from
1 April 2016 (£)
150,000
250,000
350,000
450,000
500
2,500
7,500
12,500
SDLT from 1 Apr 2016 (£) Increase in
TAX (£)
5,000 10,000 18,000 26,000 4,500
7,500
10,500
13,500
In conclusion the Buy-tolet sector faces a turbulent
tax future. Tax is set to go up
significantly and this is highly
likely to place upward pressure
on rents which will have knock
on social consequences as the
UK is currently struggling to deal
with a burgeoning homelessness
problem.
In early December 2015
Fergus and Judith Wilson
decided to sell their entire BTL
portfolio. With a 900 house
portfolio valued at £250m the
Wilsons are the UK’s biggest
landlord. They are now in their
late 60’s and have decided to
retire. However, maybe the
former maths teachers digested
2015’s summer and autumn
budgets and decided that as an
asset class BTL no longer adds
up?
£95,000
£50,000
(£7,500)
£42,500
£137,500
n/a (PA Lost)
£6,357
£42,286
(£7,500)
£41,143
(This computation assumes that the personal allowance and basic
income tax band remain the same)
For more advice contact
Paddy Harty or any of our
Tax Team TODAY...
Whilst every care has been taken to ensure the accuracy and contents of this publication, the information is intended for general guidance only.