Paying tax is an important part of running a business. It’s something we all need to do, and being aware of how the system works and what your rights are can help you to reduce your tax bills and receive additional benefits for your business.
Landlords who rent out properties to residential clients currently have certain tax rules in place which enable them to account for property costs pre-tax - meaning they are only taxed on the profit they make.
However, in the Budget set out in 2015, the Chancellor of the Exchequer announced plans to change the way landlord tax relief works. Here we’ll explain the specific change to landlord tax, what you need to be aware of as a business and how to ensure you stay up to date on tax changes that could affect your business.
Tax for Landlords: Upcoming Changes
The current tax situation means that landlords deduct the cost of their properties prior to paying tax. In real terms, this means that landlords receiving, say, £10,000 per year in revenue from a property and paying out £6,000 on an interest only mortgage would pay tax on the difference, which is £4,000. Assuming you pay 40% tax, this means £1,600 to HMRC and £2,200 to you.
When this legislation changes, as was announced in the Budget, the same landlord would receive £10,000 in revenue and be liable for tax on the full amount, less a tax credit equivalent to 20% of your interest only mortgage cost. You’d pay 40% of £10,000 (£4,000), less 20% of your £6,000 mortgage fee (£1,200) which equals £2,800 to HMRC and £1,200 to you.
This assumes your mortgage rate stays the same. If that were to increase, your cut of the profit would be even less.
The changes are scheduled to come into effect in a staged process from April 2017. As explained by property tax accountants LAS Accountants, this phased approach looks like this:
- in 2017-18 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 tax reduction
- in 2018-19, 50% finance costs deduction and 50% given as a basic rate tax reduction
- in 2019-20, 25% finance costs deduction and 75% given as a basic rate tax reduction
- from 2020-21 all financing costs incurred by a landlord will be given as a basic rate tax reduction
The impact for landlords
The introduction of these changes to landlord tax relief have been attributed to various reasons, primarily the reallocation of budget to lessen the difference in tax benefits between homeowners and landlords.
The implication in the Chancellor’s announcement was that the changes would only hit high-earning, wealthy landlords because it is those who pay in the higher tax bracket who will be most affected.
However, the proposal also means that some landlords could move into higher tax brackets and could even end up paying tax when they’re making a loss.
Some landlords have started to make provisions for this tax increase already by raising their rents. Others are setting up companies through which to trade as there are potential tax gains to be made there (and because the new legislation doesn’t affect companies - yet). There are of course some who are having to rethink their property investments for fear of losing out in the long term; according to the Telegraph on the 3rd February 2016, ‘buy to let investors to sell 500,000 properties as confidence plummets’.
These changes will only affect those landlords with mortgages. Those who are cash buyers, or companies which buy properties, won’t be affected.
What to do if your business is affected
For some landlords, their investment in property is a sideline to their day job and an investment for the future. For others, it’s a full time job, from which they draw their entire income.
No matter which side you sit on, as a landlord, you cannot ignore the implications of the new tax rulings. It’s important to bear in mind that, at time of writing this, the proposal has not been fully accepted and may be liable to change after a judicial review.
Landlords are currently faced with the following options:
- Increase rent to cover additional costs, reduce investment in properties to protect profits
- Sell off properties
- Setup limited companies through which to manage the properties
Accountants across the UK are now offering advice services to landlords who are unsure what steps to take next.
Setting up a limited company for buy to let landlords
The decision on what to do next lies with each individual landlord, and we make no recommendations here as to what you should do.
That said, one popular option at this time is to set up a limited company through which to manage your property(ies). The benefits of this are:
- Limited companies can still offset mortgage costs
- There are potential tax credits and tax gains for limited companies
- The finances for your company are separate from those as an individual
The downsides to this option are:
- Legislation around limited companies and offsetting of mortgage costs could change at any time
- Stamp duty, capital gains tax and other costs are potential deterrents
The Property Investment Project shared their advice on the upsides and downsides of setting up a company as a landlord, which is worth a read, here: http://www.propertyinvestmentproject.co.uk/blog/using-a-company-to-save-tax-on-rental-income/
How to set up a limited company as a landlord
If you did choose to set up a company as a buy-to-let landlord, the process is fairly simple. A limited company is separate from you as an individual, and your finances will be separate from the company too. You can be the only shareholder, or you may have multiple shareholders if you work with other people or seek further investment.
We have put together the following guide to help you set up a company as a landlord:
As with all decisions which affect you or your business, it’s important you understand the full implications of setting up a company before you do so. We strongly recommend you seek advice from a qualified accountant and mortgage advisor before making your decision.
published under Tax and Legislation Guides
