By Louise Misiewicz
Have you heard that Brexit will end the world?
Have you heard that unless you incorporate your property business your banks will empty into HMRC’s coffers?
Advising on property tax means dealing with more than minimising property tax liability – myself, Simon and the expert property tax specialists at Optimise Accountants also advise on property business fundamentals, too.
Recently, I’ve heard a lot about how people should incorporate their property business. If they don’t do this then surely all their income will be taxed at ridiculous rates. I am here to provide some sort of sanity check, to provide some calm amongst the sharks that prey on your vulnerability and fear.
The Budget announcement
Our team of property tax specialists wrote extensively about the Budget announcement in this article that highlighted the following:
- Mortgage interest relief cap at 20%
- Removal of the 10% wear & tear allowance
- Reduction of CGT but not for property investors
I wanted to highlight why it is not right for everyone to incorporate their property business, although we work hard to show our property investor clients how to reduce property tax.
Mortgage Interest Relief capped at 20%
I know that mortgage interest relief means that for high rate taxpayers that they will not be allowed to offset 100% of their mortgage interest costs.
In fact, someone that currently offsets £15,000 mortgage interest as a high rate taxpayer will only be able to offset half of this once the Budget announcement comes into full effect.
Are You A High Rate Tax Payer?
If you are employed at say £33,000 it would currently require you to earn just over £10,000 profits from property investments before you are deemed to be a high rate taxpayer.
As such, the £10,000 would only be taxed at 20%.
I appreciate that personal allowances will increase to £12,500 when the Budget announcement kicks in. That means that you’d need to be earning £50,000 before you become a high rate taxpayer. One of our main functions as property tax specialists is to help minimise property tax for our clients.
Let’s look at an example.
Sarah is a client of ours, and she earns £35,000 from her employment and £2,000 profit from her unencumbered properties. She will pay the same level of tax by the time the Budget comes into full swing as she does today. It’s clear that Sarah shouldn’t incorporate her property business.
Another property investor client of ours John earns £40,000 from his employment income and he makes a loss of £4,000 on his property activities because a) he his highly geared and b) he has a lot of voids.
If we look at the tax rates of 2021 he would be paying £5,500. However, given the mortgage interest relief cap the following will apply:
£30,000 Rental income
£12,000 non-mortgage interest costs
£18,000 paper property profits (not net cash)
HMRC will deem the above paper £18,000 as profit that adds to his employment income of £40,000 being a taxable income of £58,000. Clearly, £8,000 of this in the new tax world will be in the 40% income tax band even though in reality he made a £4,000 loss.
HMRC are now going to say that the £22,000 mortgage interest cost would attract 20% income tax relief being £4,400. His tax liability will be £7,900 compared to £5,500 in the new tax world of allowing all interest to be offset. Our property tax experts can advise you further on this – get in touch here.
When you absolutely should not incorporate your property business
You might say that looking at the above that John should immediately incorporate his property business. I’m now going to tell you why he shouldn’t:
- Use his property losses
- Use his spouse’s personal allowances
- Not to pay any mortgage interest cost
- Invest in a pension
- Capital Gains Tax (CGT), Stamp Duty Land Tax (SDLT) and re-mortgage costs
Use property losses
If, for example, John had £60,000 worth of losses the above impact would not change the fact that he would not pay any tax despite the mortgage interest relief cap.
After speaking with the Chartered Institute Of Taxation (CIOT) it’s clear that the losses would still be allowed, meaning that there is no tax liability in this example:
£60,000 losses carried forward
£4,000 added to the above loss
£64,000 carried forward loss
Given that John made a loss he would not be able to offset any of the mortgage interest relief.
What if John made a taxable profit of £10,000? As a high rate tax payer he would pay £4,000 tax.
One of the theories that CIOT gave was that HMRC is likely to add back the mortgage interest cost but these will be limited to the profits made. What does this mean?
£22,000 add back the mortgage interest cost
£4,400 tax relief at 20% that will be saved against future profits
As the £4,400 mortgage interest relief is greater than the £4,000 proposed tax liability he would only get £4,000 tax relief on the mortgage interest to wipe out any tax liability
I appreciate that the above is not straightforward, as the CIOT explained, but it does demonstrate that the mortgage interest relief will not affect John – despite what some media commentators are saying.
Use his spouse’s personal allowances via a Deed of Trust and Form 17
Let’s assume that John was in the unavoidable position that he had to pay more tax because of the mortgage interest relief. Let’s also suppose that John is married and his wife does not work, or because of these tax changes decides to give up her job.
The property income would go into his wife’s name using a Deed of Trust, that I explained in a previous article.
Given the above, the £4,000 loss would be carried forward and the mortgage interest relief issues goes away entirely. No extra tax to pay – which means another happy property investment client of ours, too.
Not to pay any mortgage interest cost – pay off your mortgage
If neither of the above was available to John as an option then he could simply decide to pay off his mortgages. This does mean that he would need a capital injection but let’s face it he would make more money by not having to pay mortgage costs at all and then paying 40% on the net profit.
I appreciate that most of you reading this will think that paying 40% is a bad thing.
Invest in your pension
What happens though if John decides to invest more money into his employment pension, bringing down his employment income to £20,000. This again would mean that he would be deemed to be a basic rate taxpayer and the mortgage interest relief issue goes away.
For many this may not be a solution that looks appealing. For the minority, it is something that you should seriously consider. Our property tax specialists can advise on the finer details – get in touch here.
Capital Gains Tax (CGT) and Stamp Duty Land Tax
For many investors, they will need to pay Capital Gains Tax (CGT) and Stamp Duty Land (SDLT) as we explained in our previous article never mind the cost of re-mortgaging the houses in the limited company.
As the article above suggested, there are ways of mitigating SDLT and CGT – but this is unlikely to be successful for the majority of investors.
As you can see, there are many reasons why you should not simply follow the lemmings over the nearest cliff by incorporating your property business. The saying ‘fail to plan and you plan to fail’ springs to mind.
If you want to understand how to implement this strategy or to discuss other finance and tax questions then please book some time with one of our property tax experts using the below calendar.
Please use the redeem code “Article 33” to get 33% off your next consultation call.
If you are looking for a new accountant, then please book some time with us using the below calendar. Please note that this booking is to describe our services and will not be used to discuss your personal tax affairs.