What does it mean for property investors/developers?
By Simon Misiewicz – 27th November 2015
If you’re a property investor/developer the negative effects of July’s emergency budget may have made you want to run for the hills. But don’t be too quick to give up the game — if you have a property specialist tax adviser/accountant there are ways to mitigate the changes.
George Osborne’s budget of July 8 sent shockwaves through the property industry, with some unexpected and unwelcome changes to the way property earnings are taxed.
Are you, as a property investor, going to suffer as a result?
My answer to all clients I have been briefing about the outcome is… maybe and maybe not.
There are four very big negative changes and two positive changes that will affect property investors/developers.
Negative change no 1: Higher rate taxpayers may now pay tax on properties that make an annual loss.
How can this be, you may ask? It’s all to do with the changes to mortgage interest relief announced by Osborne in the Budget.
There is “unfairness in property taxation”, Osborne said, explaining that the current system gives buy to let landlords “a huge advantage in the market”, compared with home buyers.
The Telegraph has since produced an interesting comparison looking at whether or not this advantage does actually exist.
Osborne said he wanted to “level the playing field for homebuyers and investors”, then stated: “So we will act. But we will act in a proportionate and gradual way, because I know that many hardworking people who’ve saved and invested in property depend on the rental income they get.”
Currently property investors can claim tax relief on their mortgage interest repayments at the top level of tax they pay, meaning the highest rate income taxpayers can claim as much as 45% tax relief on the interest element of their buy to let mortgages. But in future, this will be capped at the amount a basic rate taxpayer would receive as tax relief. The change will be introduced over four years from April 2017.
In essence this means that any higher rate taxpayers will now pay more tax.
Currently on £3,500 of mortgage interest payments (ie, not including any element of mortgage loan repayment) on a buy to let property:
- o If you pay 20% income tax then you are allowed £700 of this cost to be offset against your annual tax bill
o If you pay 40% income tax then you are allowed £1,400 of this cost to be offset against your annual tax bill
o If you pay 45% income tax then you are allowed £1,575 of this cost to be offset against your annual tax bill
The new proposal means that on £3,500 of mortgage interest payments on a buy to let property:
o If you pay 20% income tax then you are allowed £700 of this cost to be offset against your annual tax bill
o If you pay 40% income tax then you are allowed £700 of this cost to be offset against your annual tax bill
o If you pay 45% income tax then you are allowed £700 of this cost to be offset against your annual tax bill
So if you are a 40% income taxpayer your tax bill will rise by £700 per year (boo hiss).
If you are a 45% income taxpayer your tax bill will rise by £875 per year (extra big boo hiss).
Phil Nickin from consultancy firm Deloitte said: “This measure will almost double the effective cost of borrowing for a taxpayer on the highest rate of tax. Currently interest payments of £100 only cost £55 after tax relief, but will cost £80 from 2020. A landlord who borrows at even a modest level might end up paying more in tax than he makes in profit. ”
Some experts believe the move could also force landlords to hike rents to compensate for the blow, and there is evidence this is already happening as landlords prepare for the tax changes.
Negative change no 1 – what it means to you
Let’s look at an example to understand how it will hit your pocket…
Property investor Jo has:
• £10,000 net annual rental income
• £12,000 mortgage interest costs
The current system would mean that if Jo was a 40% (higher rate) income taxpayer she would not pay any tax at all since tax payable is based upon the amount of profit made. Profit is calculated as income minus allowable costs, so using the above information Jo made £10,000 – £12,000 = -£2,000, ie, a loss and no profit. This means Jo pays £0 tax on her rental income.
In the new regime the following applies to Jo however:
• £10,000 net annual rental income
• £6,000 mortgage interest costs (capped at the 20% tax relief) This means Jo makes a profit of £10,000-£6,000 = £4,000
Since Jo doesn’t have this profit in a limited company and pays 40% income tax she will now pay £1,600 of the £4,000 profit to HMRC as tax (big boo hiss).
Negative change no 2: Basic taxpayers who own property to be pushed into higher tax bands
At the time of the above announcement on tax relief, the Government claimed that basic taxpayers with buy to let properties would be unaffected, and that only one in five landlords would be hit by the changes, however, this number has been called into question by many experts since.
In particular, the Residential Landlords Association (RLA) recently published findings of research it conducted, which suggested in fact 60% of landlords who are currently basic rate taxpayers will be pushed into higher tax bands by the changes.
Under the new rules, rental income will be reported differently on self-assessment returns, and rather than adding their profit in the rental income section after deducting all costs, including mortgage interest, the new system will see them reporting rental income after deducting all costs EXCEPT mortgage interest, then having a relief added back later on.
The devil really is in the detail for basic rate taxpayers, many of whom are only just waking up to the fact this change will affect them in future.
Imagine in the above example that Jo was a basic rate taxpayer earning £40K per annum from her job. Under current rules, she was making a loss from her rental income, so she would remain a basic rate taxpayer. Under new rules, that £10,000 in rental income is added to her income, before a £6,000 relief is claimed and hey presto, she’s a higher rate taxpayer and her tax bill rises even further.
It’s not all bad news, however, particularly if you invest through a limited company.
Positive change no 1: Corporation tax (tax paid on profit from a limited company) will drop to 18% over the next four years from the current level of 20%
“Today I announce that I am cutting [corporation tax] again. Britain’s corporation tax rate will fall to 19% in 2017 and 18% in 2020,” said Osborne, in a bid to “show the world the UK is open for business”.
This was good news indeed – the UK’s corporate tax rate already compares favourably with other countries, for example, the comparable tax rate in the US is 40%, in France it’s 33.3% and in Scandinavian nations it can be as high as 50%!
Howard Sears, managing director of the venture capital firm Astuta, said: “For British business, this was a frankly barnstorming budget. Confidence among UK businesses is already strong but these latest reductions in corporation tax will supercharge it.”
Positive change no 1 – what it means to you
This means that in 2017 for every £100 profit you make in your limited company you will keep an extra £1 compared to now (woo hoo).
By 2020 for every £100 of profit you make in your limited company you will keep an extra £2 compared to now (double woo hoo)!
However, don’t get too excited… with one hand they give and with the other they take away!!!
Negative impact no 3: Scrapping 10% wear & tear allowance
Another expense landlords can currently deduct from their tax bill related to furnished properties (eg, HMOs or holiday lets) is 10% of the rent charged for wear and tear – even if they have made no actual improvements during that tax year. From April 2016, the Government will replace this with a scheme that ensures landlords can only deduct expenses they actually incur in relation to the property for that year.
HMRC have previously prevented the cost of furnishings to be offset against property income. Time will tell if the cost of furnishing a property will now be allowed for given this latest change.
This will severely impact high rate taxpayers who rent out HMOs.
Negative impact no 4: Dividend taxation change
George Osborne announced in his 2015 Summer Budget that the current dividend tax credit system will be replaced by a tax-free dividend allowance of £5,000. Sounds good doesn’t it? Hold onto your hats though…
This means all dividends earned outside of pensions and Isas will be tax-free up to £5,000, then taxed at 7.5% for basic rate taxpayers.
The change will have a big impact on small businesses, particularly those that pay themselves, as directors, small salaries to ensure an entitlement to state pension, taking the rest as dividends.
Importantly, however, there is still an advantage of paying through dividends rather than wages because there is no need to pay National Insurance on dividends.
Positive change no 2: Inheritance Tax nil rate allowance increase
From January 2017, the government will raise the inheritance tax (IHT) threshold from £325,000 per person to £500,000.
Example of positive change no 2 – what it means to you
This means that a married couple will be able to pass on assets worth up to £1 million, including a family home, without their inheriting family/friends paying any IHT at all.
Currently, the beneficiaries of an estate must pay 40% tax on any portion of its value that exceeds the £325,000 per person.
So if you have an inheritance of £1 million or more from a married couple, your inheritance tax bill has just dropped by £140,000! Phew.
The bad news is in some cases house price inflation (particularly for property investors who significantly add value to their properties) will probably outpace the IHT tax relief increase. Still £140,000 less to pay is fantastic!
Do all these changes mean you should now be buying all your properties in a limited company?
It still depends on your personal circumstances. It certainly means that the profit level you achieve per year drops a little lower as a trigger to whether or not to use a limited company rather than put your property income through self assessment.
So how does all of this impact me as a property investor and what do I need to do now to prevent my tax bill from increasing?
As you can probably imagine everyone’s personal situation is slightly different and the above tax changes need to be looked at in relation to your future plans for property investments and strategies. Most likely, however, whatever you do as a property investor, this budget will affect you and if you do nothing your tax bill will increase and in some cases increase dramatically!
Now is definitely the time to book a consultation with Simon Misiewicz if you haven’t already to plan how to minimise the negative impacts described above on your property profits.
Don’t forget there are some positive outcomes from the budget and we can also help you maximise these too – with our help you may no longer need to consider running for the hills after all!
If you wanted to understand how to implement this strategy or to discuss other finance / tax questions then please book some time with us using the below calendar
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