tax

Changes to Capital Gains Tax — How are Landlords Affected?

The 2016 budget inaugurated some major changes to the capital gains tax, which could have some major implications for buy-to-let landlords – especially those with diversified investment portfolios, and other companies.

 

What are the changes?

Effectively, there has been a decrease in the capital gains tax on most "chargeable gains": The 18% rate became 10%, and the 28% rate became 20%. One exception, however, is those chargeable gains that accrue on residential properties that do not fall under the relief umbrella for private residences.

The former 28% rate was generally applied to higher-rate taxpayers, trustees and companies, whereas the 18% rate covered anyone not in those categories (generally lower rate tax payers).

The residential property exception under the new law is pretty stringent. Under the banner of "residential property", the measure includes any land that has had a dwelling on it at any point during the current ownership.

 

Why were they implemented?

The idea behind these policy changes is to promote business growth and investment activity. The general wisdom is that low capital gains rates mean companies are freed up to do what they need to; essentially, to expand their capacities and create jobs. The idea behind the exception with regard to residential property is to encourage investment in companies, rather than properties. The new rates will be affecting all relevant gains realised since 6 April 2016.

 

What will the impact on the economy be?

The changes will significantly decrease the amount flowing into the Exchequer coffers, to the tune of £600-700 million per year over the next five years, according to the Office for Budget Responsibility. On the other hand, it will significantly bolster company coffers, giving businesses the capital they require to grow and open up new jobs.

It will also have a major effect on those individuals and families with significant capital holdings, and those who make multiple investment transactions throughout the year. With new lower capital gains tax liability, they will now have more room to play with when it comes to managing and growing their investments.

Of course, things will not change quite so much for those holding residential properties, unless of course they opt to switch some of their investments from properties to enterprises. However, the changes are designed so that they do not disproportionately affect any particular income group.

The government holds, in addition, that there will be no negative impact on businesses or other organisations, as the changes are aimed primarily at individuals with capital gains tax liabilities, personally or professionally.

 

What should I do if I am an unincorporated buy-to-let landlord?

This is the question many people are asking, and unfortunately there’s not a perfectly clear answer.

One possible option is to incorporate, which also allows you to avoid private income tax rates, and take advantage of corporation profits taxes, which decreased in April 2017. However, there are of course other costs to consider involved in running a business, including administrative costs and those related to renegotiating mortgages.

Claiming of tax relief on Mortgage Interest over the next few years

If you're a little confused over changes in tax law, this article will explain what this means for landlords and what to expect in practical terms. 

Who is likely to be affected

If you're an Individual that receive rental income on residential property in the UK or elsewhere and incur finance costs (such as mortgage interest), excluding where the property meets all the criteria to be furnished holiday letting, then this legislation will affect you. Essentially 100% of our clients who are landlords! 

General description of the measure

This measure will restrict relief for finance costs on residential properties to the basic rate of Income Tax. This will be introduced gradually from 6 April 2017. Finance costs include:

  • mortgage interest
  • interest on loans to buy furnishings
  • fees incurred when taking out or repaying mortgages or loans.

No relief is available for capital repayments of a mortgage or loan.

Landlords will no longer be able to deduct all of their finance costs from their property income to arrive at their property profits. They will instead receive a basic rate reduction from their income tax liability for their finance costs. Landlords will be able to obtain relief as follows:

  • in 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate reduction.
  • in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
  • in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
  • from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction.

Making sense of these new rules

The change to mortgage interest relief in the 2015 emergency Budget was not only a bit of a shocker but also tricky to understand. Most media commentators and indeed many accountants weren't entirely sure what it meant either. With no particularly clear or simple example online anywhere else, I thought I'd post a few examples here. We've got sometimes to discuss the rights and wrong and what to do about it, but for now, here's the breakdown.

The current rules

At the moment, (until April 2016), you can deduct your mortgage interest (plus associated costs like arrangements fees) along with all your other costs before determining your taxable profit.

So, to take a simple example:

£10,000 rental income

£5,000 mortgage interest costs

£1,000 other costs

= £4,000 profit

You are then taxed on that profit at your marginal rate - so basic rate (currently 20%) taxpayer would pay a tax of £800, and a higher rate (currently 40%) tax paper would pay £1,600.

(There's also an 'additional rate' of 45% for income about £15,000 which I'm ignoring here for simplicity)

The new rules

By the time the new measures have fully taken effect in April 2020, you will no longer be able to deduct mortgage interest costs from your taxable profits. Instead, everyone will be able to claim a basic rate allowance for their finance costs, irrespective of their marginal rate. This is being phased in over four years.

So, using the same example as able with the new rules, the figures would be:

£10,000 rental income

£5,000 mortgage interest costs (not deducted)

£1,000 other costs

= £9,000 profit

Yikes! A basic rate taxpayer would pay £1,800 tax on that new £9,000 profit, and a higher rate taxpayer would pay £3,600.

BUT WAIT - everyone gets to claim a basic rate deduction of 20% of that £5,000 mortgage interest cost. That's £1,000. So the final portion is:

Higher rate tax payer:

40% tax on £9,000 profit = £3,600

Minus £1,000 deduction (20% of £5,000 interest cost)

= £2,600 tax to pay

Basic Rate tax paper:

20% tax on £9,000 profit = £1,800

Minus £1,000 deduction (20% of £5,000 interest cost)

= £800 tax to pay

So what's happened?

First, you'll notice that the basic rate taxpayer ends up paying exactly the same amount of ta under the new system £800. The higher rate taxpayer however, ends up paying £1,000 more. 

But this doesn't mean that the basis rate taxpayer is unaffected. Because the deduction is applied after calculating the taxable profit, everyones' 'profit' has actually increased - from £4,000 to £9,000.

This means that people whose income (from property plus employment and other sources) is currently below the higher rate threshold may end up getting pulled into the higher rate band as a result of their higher property 'profits' 

The silver lining, such that it is, is that the higher rate threshold will have risen from its current £42,385 to £50,000 by the time this measure takes full effect in 2020. 


About the Author

Phillip Bowick, from The Provincial Tax Shop, runs an accounting practice with over 30 years experience. They can prepare accounts from your own records whether these be manual or computerised.

They offer:

  • A free no-obligation discussion about your business requirements
  • Fixed accounting fees agreed in advance and not dependent on income level
  • VAT registrations and advice
  • Tax planning
  • Company forecasts

If you would like any specific help and tax advice, please call (01942) 233737 or write to info@provincialtaxshop.com

 

Hammond's Autumn Statement: What It Means for Landlords

This year’s Autumn Statement from Chancellor of the Exchequer Philip Hammond leaves much to be desired from the perspective of buy-to-let landlords and others in the private rental sector. The biggest disappointment was the fact that the Chancellor’s remarks reflected no planned changes to the unfortunate stamp duty hikes, or to dreaded changes regarding mortgage relief.

The rise and fall of stamp duty – or so we thought

The stamp duty increase was announced last spring with this year’s budget, by Hammond’s predecessor George Osborne. It lowered the value threshold for the homes falling under the tax, and increased the rate significantly on those properties that could be considered a second home.

The idea was to discourage people from buying second and third homes and free up UK housing stock to stifle rising costs. But the change has put major brakes on the housing market, and has not raised nearly as much money as its boosters predicted.

Analysts say that the Exchequer has brought in less than half of the £700m the stamp duty was expected to generate. It has also hit buy-to-let landlords hard, since many of their properties are considered second or third homes under the law.

It was widely thought (or hoped!) that the change in Chancellors that happened this summer would lead to a paring down of the law, or at least a review of the tax.

There was major action on the buy-to-let market at the beginning of the year before the stamp duty hike, but now those investors seem to have stopped expanding their property portfolios. They are also borrowing a whole lot less, so the tax hike has had serious repercussions for multiple areas of the economy.

Many landlords have pointed to stamp duty in particular as being the thing that has held them back the most from expanding their businesses over the course of this year.

Experts believe that a repeal or reduction of the stamp duty would be far and away the best option for giving the market the little kick it needs, but so far the new administration does not seem to agree.

Tax relief will go ahead and get scaled back

Another upcoming change that’s going to affect landlords has to do with gradually scaling back property-related tax relief. Buy-to-let landlords are currently allowed to use tax relief to offset all of their mortgage interest, but as of this spring the phasing out of this rule will begin.

The change has been scheduled to happen in steps with nearly half a million basic-rate payers being pushed into the next higher bracket in April 2017, and the relief for higher-rate payers scheduled to be gutted over the next three years.

The move has been expected to force landlords to push the costs onto tenants by increasing rents – and thus gravely affecting the frequency of tenant default.

Commentators had hoped the new chancellor would also propose a fix for this problematic situation, but no sign of such a move appeared in the Autumn Statement.