Buy to Let Shake Up
The 2015 Summer (second) Budget saw a number of announcements that will not be welcomed by residential property landlords.
The announcements included changes to the allowable deduction for finance costs which could have a significant impact for individuals with buy to let properties, and the replacement of the 10% wear and tear allowance.
Mortgage Interest Relief
Under current rules, individuals with buy to let properties can claim tax relief on mortgage interest payments. This is done by reducing the rental income received by the interest payments and therefore the individual receives income tax relief at their highest marginal rate of tax on the interest payments made.
With effect from 6 April 2017 the current position will be scrapped in favour of new rules that will provide tax relief at the basic rate of tax only.
This announcement will affect all higher and additional tax rate landlords as well as some who pay tax at the basic rate (due to the mechanism of the new relief). Some commentators have warned that the proposal could provoke a hike in rents to compensate landlords for the extra tax hit.
The new relief will be phased in from April 2017 and will be fully implemented by April 2020.
These new rules do not apply to companies but they do apply to individuals, partnerships and Limited Liability Partnerships. They do not apply to businesses dealing in property or developing property, as they are targeted to “dwelling related loans”.
Restricting tax relief on finance costs will primarily affect landlords who have used high loan to value borrowing to fully offset interest costs against rents. These landlords may find themselves struggling to pay their increased tax bills.
Wear & Tear Allowance Replaced
In addition, wear and tear (W&T) allowance is to be scrapped from April 2016. At present, landlords of fully furnished rental property can claim a deduction equivalent to 10% of rents received regardless of their actual expenditure in the year.
The W&T allowance will be replaced by a deduction for the actual costs incurred on replacing furniture in an attempt to align tax relief with a landlord’s actual economic position. It will operate by giving relief for the cost of a replacement asset less any proceeds received on the sale of the old asset. The initial cost of purchasing the asset will not be a deductible expense. Similarly, any purchase deemed to be an improvement will not receive relief. It is anticipated that any incidental improvements by way of an advance in technology would be allowable.
You should note that this change does not affect the reliefs available for furnished holiday lets.
The upside of this is that landlords will now be entitled to tax relief even if their property isn’t let fully furnished. The change also means that landlords no longer need to make the distinction between furniture or fixtures and fittings.
It is hoped that linking tax relief with actual costs will encourage landlords to replace their furniture more regularly. There will however be greater administration involved as landlords will be required to keep records of all replacements in order to claim the relief.
Rent a Room Relief
It’s not all bad news. Rent-a-room relief is set to rise to £7,500 from April 2016. The limit has been fixed at £4,250 for many years but homeowners could now earn up to £7,500 tax free by renting out a room in their home. This will realign the relief with the average room rent in the UK. Encouraging people to take in lodgers could help with the current housing shortage. The increased limit will also reduce administration and compliance costs for many, as the majority of lodger-landlords will no longer have to declare this income on a tax return.
In summary, the budget hasn’t been overly kind to landlords. Most will see a drop in their after tax profits and some may try to pass this shortfall on to tenants. For landlords of fully furnished properties, only those who choose to replace assets on a regular basis will benefit from the withdrawal of the wear and tear allowance. Those with part furnished properties will welcome the extra relief available on their replacement expenditure.
Taxpayers who believe they may be effected should start planning now and contact our tax department for further guidance.
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