Residential property investors are facing a number of tax reforms that will fundamentally change the profitability of their portfolios.
The changes will affect those with large portfolios as well as those with just one or two properties, and could leave landlords paying more tax than the profits their properties generate.
The Government in its 2015 Budget announced major reform of the tax regime surrounding the residential rental markets, leaving landlords and investors facing a tax landscape that will change every year for the next five years.
And in November, the Chancellor George Osborne in his Autumn Statement announced a three per cent increase is stamp duty that will affect buy-to-let landlords and second home owners look to buy new properties.
The first reforms – to the wear and tear allowance and to the rent a room relief – take effect from April 2016, with deeper reforms on tax relief on mortgage interest payments being phased over a four-year period from April 2017. Landlords and investors need to understand how these reforms will affect them and take steps now to prepare.
Wear and Tear Allowance
Landlords letting furnished properties have traditionally been allowed to deduct a Wear and Tear Allowance from their taxable rental income. This allowance is calculated as 10 per cent of the relevant rental income and covered furniture, furnishings and white goods.
From April 2016 this allowance is to be replaced with a new relief available to all landlords of furnished and unfurnished properties. Although final details of the changes are not yet available, it is anticipated the new rules will allow a deduction based on the actual costs of replacing furniture, furnishings and white goods. There will be no relief for the cost of purchasing the original items.
Certain items – for example, baths, toilets, boilers, and fitted kitchens – are deemed to be part of the fabric of the property itself and will continue to be treated as a repair to the property.
Mortgage interest relief
By far the most troubling for landlords and investors is the reduction in income tax relief residential landlords will be able to claim on finance costs. Most critically, finance costs include mortgage interest, but also extend to mortgage arrangement fees and interest on loans to buy furniture or fixtures.
The measures are expected to apply to most residential landlords who are subject to income tax on their property income (including trusts and personal representatives of estates of deceased persons), the exception being landlords of furnished holiday lets. The new rules will not apply to commercial property or to companies charged to corporation tax.
The reforms will be phased in over a four-year period from April 2017, and will see landlords having to pay more tax on their income.
Some commentators believe that investors may respond by putting their properties into limited companies, selling properties or choosing not to expand their existing portfolios; others may choose to raise the rents charged to tenants to compensate for higher tax bills. Investors are unlikely to make any rash decisions without first seeking advice.
Rent a Room Relief
Finally, some good news. Rent-a-room relief, frozen at £4,250 since 1997, will increase to £7,500 from April 2016. It will apply to income from letting out furnished accommodation – from an individual room to an entire floor – in a private home. It is also possible to opt in to the scheme at any time if you are a resident landlord, whether or not you own your home. The relief also extends to bed and breakfast accommodation and guest houses.
This article was written by Ian Miles, a Partner and head of the Private Client team at James Cowper Kreston
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Limited companies could be the answer for some landlords, even those without large portfolios or high levels of gearing, but there are downsides too; not least of which is the cost of incorporation. A transfer of ownership is treated as a market value transaction, exposing it to both capital gains tax and stamp duty.
Another option is to retain the existing portfolio and make only future purchases through a limited company, but again, this won't be the right choice for everyone. Due to the different tax treatment and added costs involved, landlords should speak to a tax professional or financial advisor before making a decision.
Most crucial is for landlords to be aware of the changes coming up, as adaptation is the key to success. Our buy to let guide for 2016 and beyond examines in detail the changes facing the market over the coming years, as well as what options landlords have to stay ahead of the curve.
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