The government recently announced a number of changes which affect how rental income from residential property will be taxed in the current year and going forward.
One of the proposals will introduce a new furniture relief which will impact all landlords – this replaces the wear and tear allowance for fully furnished residential properties. The new replacement furniture relief which came into effect from 6 April 2016 will apply to all residential properties regardless of whether they are fully furnished or not. This new relief does not apply to furnished holiday lets as they are already entitled to capital allowances.
The other two major changes specifically target individual and trustee landlords. From 6 April 2016 an additional 3% Stamp Duty Land Tax charge applies on every residential property acquisition (unless the property is your main residence). In certain circumstances this has had some unintended consequences i.e. a parent buying a property for their child. H M Revenue and Customs have also stated that this charge will apply where a company buys its first residential property – this is to prevent individuals from circumventing the rule and setting up a separate company for each new property acquisition.
New rules, which will dramatically change how individuals can claim tax relief on their loan interest charges, comes into effect from 6 April 2017. The changes will be staggered over three years with the full restriction being in operation from 6 April 2020 onwards.
The changes have received a lot of attention from the press, as they effectively mean that you will no longer be entitled to claim the loan interest as a deduction against the rental income. Instead you will only be entitled to claim basic rate tax relief for the loan interest costs.
The effect, in particular of the loan interest charges in a worst case scenario, could see individuals being subject to tax on an amount that could be significantly more than their actual profit. Because the taxable profit will be higher, this will have a knock on effect and could lead to restrictions elsewhere i.e. personal allowances if the total income is more than £100,000 or the high income child benefit charge could be applied.
The recent changes, which are clearly aimed at personal landlords, have been introduced in part to prevent another property market crash. The few options now available to landlords are:
• do nothing and accept the increased tax charges
• sell up
• incorporate the residential business to mitigate the new tax rules.
But be warned – aside from the first option, the remaining two could potentially give rise to unexpected tax charges.
For example if you were to sell all your properties (as this is not a trading activity) you are then not entitled to claim Entrepreneurs’ Relief on the disposal. The chargeable gain would be 28% (assuming that you are a higher or additional rate tax payer). Because of this it may be a sensible option to transfer the properties into joint names before any disposal takes place – however if there are outstanding mortgages, a Stamp Duty Land Tax charge based upon half the value of the mortgage will be levied, potentially negating the capital gains tax saving by the utilisation of two capital gains annual exemptions and utilising one spouses’ basic rate band.
There is a specific capital gains tax relief available where you transfer all of the residential properties to a company. However, for this incorporation relief to be available, you must be doing something other than passively holding the investments.
So, for example if you employ a letting agent to look after your properties and you just receive the rents, then you wouldn’t be entitled to claim the relief. Consequently, a capital gains tax charge would arise. Incorporation relief only deals with the capital gains tax aspect, Stamp Duty Land Tax will also be due on the full market value of the properties (regardless of whether there are any mortgages or not).
It may be possible to undertake tax planning to ensure that no capital gains or Stamp Duty Land Tax charge arises. Before undertaking any tax planning we recommend that you contact a member of our team so that we can review your property portfolio and provide recommendations on how this should be structured in light of the new rules.
For further information please contact a member of the team below.