Landlords, are you affected by the finance cost relief changes?

Residential landlords have been subject to an onslaught by the tax man lately. With each wave of legislative change comes new demands, new taxes, and new compliance requirements. Unfortunately for landlords, this upsurge shows no sign of slowing down just yet.

As of 6 April last year, new measures restricting finance cost relief for residential landlords came into play. These changes mean individual landlords will no longer be able to deduct all of their finance costs from their property income to arrive at property profits. They will instead receive a basic rate reduction from their income tax liability for their finance costs.

Thankfully, these changes are being phased in over a 4 year period, giving residential landlords a chance to adjust and adapt. Landlords will be able to obtain the following relief:

2017/18 – the deduction from property income (as it is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate reduction.

2018/19 – 50% finance costs deduction and 50% given as a basic rate tax reduction.

2019/20 – 25% finance costs deduction and 75% given as basic rate tax reduction.

2020/21 – all financing costs incurred by a landlord will be given a basic rate tax deduction.

Finance costs - the definition of 'finance costs' includes mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans.

Who is likely to be affected?

Individuals that receive rental income on residential property in the UK or elsewhere and incur finance costs (such as mortgage interest) will be affected. However, excluded from these rules are limited companies and landlords who own commercial properties or property which is classified as a furnished holiday letting.

Ultimately, the effect of these changes could push a significant number of property investors into higher rates of income tax.

The limited company solution

Landlords who hold property personally could potentially transfer their existing property portfolios into a limited company. This would allow 100% of the mortgage interest on these properties to be an allowable deduction for corporation tax as the new rules do not extend to limited companies.

Tax implications

A transfer of properties from an individual to a limited company would ordinarily trigger the following taxes:

Capital Gains Tax (CGT) – The properties would be deemed to be sold at market value. The original cost of the properties could be deducted from this to calculate the gain. For a higher rate taxpayer, the gain on residential property would be taxed at 28%

Stamp Duty Land Tax (SDLT) – SDLT would apply on the full market value of the properties transferred. For example, property valued up to £125,000 would attract SDLT of 3% of the market value.

Tax planning for landlords

Early tax planning is crucial in order to minimise taxation liabilities on the transfer of properties into a limited company. A clearance letter could be submitted to HM Revenue and Customs to obtain clearance to transfer the property business as a going concern and in its entirety into a limited company. This would allow the properties to be transferred at no gain no loss thus mitigating the potential tax liability, and in addition gaining relief from the SDLT.

Eligibility

This option is typically only applicable to professional landlords who effectively operate a property business. An investor with a small property portfolio who derives the majority of their income from another means would typically not be eligible for this option.

Other key points

The transfer of properties from an individual investor to a limited company would typically require a new funding package to be negotiated in the name of the new limited company.

Contact

Property tax issues are often very complex and it is vital that professional landlords who are looking to transfer their portfolios into limited companies get specialist advice. Our personal tax team can sit down to together with you and assemble a bespoke plan to help mitigate the effects of tax.

If you're a landlord with multiple properties in the North East, please get in touch with me to arrange a free, no-obligation meeting to discuss your requirements.