For residential property landlords subject to higher rate tax, the tax return signed and submitted before the 31 January next year will signify the end of full mortgage interest relief secured on these properties. For those waiting for the outcome of the court case brought by ‘Axe the Tenant Tax’ group or simply for the government to have a change of heart, with the restrictions taking hold now might be the time to revisit your position.
A reminder of the rules
The deductibility of interest and other finance costs (such as arrangement fees), against rental property income will be restricted starting with the current tax year 2017/18.
2017/18 75% may be deducted against rental income
2018/19 50% may be deducted against rental income
2019/20 25% may be deducted against rental income
The balancing amount of finance costs may attract basic rate tax relief, but this is subject to a convoluted calculation. A similar provision applies to interest paid on debt raised to invest in a property partnership.
These rules do not impact commercial property, furnished holiday lets or properties held by companies.
What are my options?
- Accept the increased tax charge (the first self-assessment payments impacted will likely be 31 January 2019).
- Contemplate income tax mitigation reliefs and investments, which could include:
- Personal pension contributions;
- Enterprise Investment Scheme relief
- Social Investment relief
- Venture Capital Trusts relief.
- Consider whether the property ownership proportions are held tax efficiently.
- Weigh up the impact of incorporating your residential property business
Incorporating a residential property business
Step 1 – consider the tax exposure
- Capital Gains Tax – the properties will be considered to have been transferred at their current market value, which may result in an overall capital gain. Incorporation relief may be available, non-statutory clearance can be obtained from HMRC.
- SDLT – an exemption exists for partnerships, multiple dwellings relief may be available on other transfers reducing the SDLT exposure on transfer.
- Capital allowances – residential properties generally do not attract capital allowances, assets used in the rental property business can be transferred without creating an additional tax liability.
- VAT – not applicable for residential property businesses.
- Income tax – if incorporation is chosen, review your payments on account in light of your altered income sources.
- Corporation tax – the company will pay its first corporation tax liability nine months after its accounting year end.
Step 2 – consider any additional compliance costs
- The annual cost of company filings and company law obligations.
- ATED reporting for residential property valued over £500,000.
Step 3 – talk to the bank
- It might be worth checking whether the bank is amenable to re-financing within a corporate structure and whether there are any punitive costs before step 1.
- Ideally, your accountants’ report will outline the initial costs associated with step 1 and 2 but also the tax savings over the longer term, to assist with any detailed discussions.
- With this report in hand (and possibly your accountant), your bank should then be able to formalise the mortgage offering for the properties transferred into the company structure.
Step 4 – instruct your solicitor
- Your solicitor should be engaged for the conveyancing and submission of SDLT returns on transfer.
Step 5 – practicalities of incorporating
- A company bank account will need to be set up.
- Update lease or assured shorthold tenancy agreements.
- Insurance policies will need to be obtained in the company name.
- Inform any suppliers such as utility providers or the council.
- Those with a HMO licence should contact the council.
Tax rules are subject to change so taking the decision to incorporate your rental property business should be given due consideration. That said, whilst the youngest generation struggle to get onto the property ladder, it would not be politically astute to remove these finance restrictions.
If the intention is to hold the property portfolio for the longer term, company structures can assist with expanding the property portfolio by limiting the tax exposure on profits generated. Corporation tax rates are currently very low, (19%), however extracting profits will likely attract further tax charges on the owners. As an alternative, rather than incorporating an existing property business, any new acquisitions could be acquired within a corporate structure.