Most of us aspire to owning our own home, but in the UK, escalating property prices, driven ever-higher by demand on a limited housing stock makes it difficult for many people to get a foot on the property ladder.
The government is keen to address this issue, and has launched a range of initiatives which aim to make home ownership more affordable. Increasing the number of properties available for sale is obviously key, and as part of its overall strategy, the government is taking action to make it far less financially attractive to be a landlord, changing the rules on letting out fully furnished properties, and increasing the tax burden on landlords in the higher rate tax bracket.
- Wear & Tear Allowance Scrapped
With effect from April 2016, the government abolished the ‘wear and tear’ allowance’, previously available to landlords of furnished properties to cover wear and tear of furnishings. Instead of the allowance – which was based on 10% of gross rental income, and available regardless of whether any replacements had actually been made – a new system has been introduced requiring landlords to keep detailed records, and giving tax relief only on the basis of like for like replacement value.
Under the new regulations, a landlord replacing an item with an original value of (say) £500 with an item of the same value, will have to be able to prove the original purchase price to qualify for tax relief on the replacement. They might choose to pay more than £500 for the replacement, but relief will only be based on the original value. If they do spend more, when the new item subsequently needs replacing they’ll be able to claim relief based on the higher amount.
The new rule may have unintended consequences for tenants, leading to a gradual decline in the quality of rented accommodation, but for landlords it’s going to significantly increase administration, requiring them to keep a fully detailed paper trail of all replacement furnishings. Spreadsheets will help, but all original receipts will need to be retained for inspection if challenged, adding another layer of complexity for landlords to deal with.
- Phased Reduction of Interest Relief on Buy to Let Mortgages
From April 2017, new rules start to be phased in which will seriously restrict the amount of interest relief landlords in the higher tax bracket can claim on buy to let mortgages.
At this moment in time, landlords get interest relief at 20%, 40% or 45% depending on the tax band they’re in. On this basis, a 40% landlord who has a rental income of £1,000 each month and pays £600 in interest, will (assuming there are no other costs), make a £400 profit which will be taxed at 40% i.e. £160. Under the new rules though, higher rate tax paying landlords will start to pay more tax as interest relief is gradually reduced, eventually being restricted to 20%. Taking our earlier example, the same landlord will pay 40% on £1000 profit and get tax relief on £600 at 20% i.e. £120. In other words, under the new rules, they’ll see their tax liability increasing from £160 to £280!
Is it Time to Go Limited?
Some landlords impacted by the phased reduction of interest relief may want to consider operating their property portfolios under a limited company. While the idea of paying 20% corporation tax on profit and not being penalised in relation to interest relief may be appealing, it’s important to remember that any profit will still need to be taken out of the company – normally in the form of a dividend payment or as a salary, both of which will be liable for tax. A higher rate tax payer who chooses to take money out of the company as a dividend will end up paying an effective tax rate of 46%:
Operating a limited company also comes with legal responsibilities and administrative costs, but it may still be an attractive option for a landlord who can afford to extract profit in small, tax-efficient sums, or who is not interested in taking profit out immediately – perhaps because their portfolio represents part of a retirement plan.
While transferring existing properties into a limited company might also attract stamp duty, negating any benefit, it might still represent a viable option for a landlord planning to acquire new properties.
Confused About What To Do?
Let Inca Advise What’s Best for You!
If you’re a higher rate tax paying landlord, and you’re concerned about the effect these new rules will have on your income, Inca can help. We can advise whether a limited company is the right solution for you, and recommend a plan of action to help you minimise your tax liability. Call us now on 01235 868888 for an initial chat!