We will answer the following question. How do you mitigate the impact of Section 24 mortgage interest relief cap?
If you have not done so already we recommend that you read our first article where we describe exactly what Section 24 mortgage interest relief cap is. We will also describe how Section 24 mortgage interest relief cap will increase your tax liability. Tax will be increased by anyone that rents out residential buy to let properties, which has a buy to let mortgage in place. In this article, we will focus on how you can mitigate the impact of section 24 mortgage interest relief cap on your buy to let portfolio.
Mortgage interest relief solution – Use a Deed of trust
You could transfer property income If you have a spouse that is a lower tax earner. If they remain a basic rate taxpayer once the beneficiary of the properties is transferred then Section 24 may be mitigated. You will need to book some time with us to discuss this.
A deed of trust will be required to show that the beneficiary interest has been transferred over. If you currently own the property, then you will also need to complete a form 17 to tell HMRC that the beneficiary entitlement is no longer 50/50.
You need to be mindful that you need to speak with your mortgage lenders. Please see their terms and conditions to see if you can transfer the beneficiary of the property. If they require the second person to be added to the mortgage then there could well be an SDLT implication as there will be a land transaction based on their share of the mortgage. There is now a double effect with the 3% SDLT surcharge in addition to the SDLT standard rates.
Download your buy to let tax guide here, written by our property accountants
Mortgage interest relief solution – Change of use: holiday lets / serviced accommodation and commercial properties
Section 24 only affects residential properties. If you were to change the use of the property to serviced accommodation, holiday lets or commercial properties then Section 24 may be mitigated.
You need to ensure that you get planning from the local authority to see permission to change the use of the property from C3 to the new use class. You can get more details from the planning portal.
Please check with the mortgage lenders. If you have a standard buy to let mortgage and wish to use the property for another use then you will need to seek alternative financial arrangements.
We have also written a more detailed article all about investing in commercial properties. Be sure to take a read.
By changing the type of income you make form property is a clear way for you to mitigate the impact of section 24 mortgage interest relief cap.
Mortgage interest relief solution – Pay down your buy to let mortgages
We have seen on a number of occasions that the rate of tax on their property income is forecasted to be between 45% and 135% for higher rate taxpayers once Section 24 is fully implemented by 2020/21.
If you pay off mortgages the maximum tax rate will be 40% for higher rate taxpayers and 45% for additional rate taxpayers.
Paying off mortgages and saving tax may now be a better strategy than using your money to invest in more properties in your own name or indeed in a limited company.
Here is an example of this by 2020/21 when Section 24 is fully implemented
£20,000 rental income
(£10,000) mortgage interest cost
£10,000 cash profit
HMRC will deem the tax return as follows:
£20,000 rental income
(£10,000) mortgage interest cost
(£8,000) tax based on 40% (high rate taxpayers) X £20,000
£2,000 cash left after tax
£2,000 add back tax relief 20% X £10,000
£4,000 cash left after tax
£6,000 tax liability (previously 2015/16 – would have been £4,000 (£10,000 profit X 40%)
The above £6,000 tax is 60% of the rental profit (rental income less mortgage interest). You can also clearly see that the bank and HMRC make more money than the person in the above example.
As you can see there is a hike in tax. Rather than buying more properties in a limited company you could pay of the mortgage and the tax would be as follows:
£20,000 rental income
£8,000 tax (as before)
£12,000 cash after tax
The person now has to pay £2,000 more in tax than the above example but because they have paid off the mortgage they receive more net cash.
Mortgage interest relief solution – Make pension contributions
The less taxable income you have, the less tax you pay. It is clear that pensions contributions can mitigate the impact of section 24 relief cap.
The maximum amount of money that you can invest in your pension is £40,000 per year. The actual pension contributions you can make is just £32,000 as £8,000 is added by the government. In practice £40,000 X 0.8.
The amount of pension contributions you can make is restricted to Net Relevant Earnings (NRE) of £3,600. This means how much money you earn in regard to:
- Employment income
- Self-employment income
Please note that property investment, interest and dividend income is not taken into account. If you only have property income of say £50,000 you will still be only allowed to invest £3,600 (NRE rate).
There are other financial benefits of making pension contributions such as National Insurance savings, reducing the impact of losing your personal allowance if you earn more than £100,000. It also helps you to maintain all of your child benefit allowances if you earn more than £50,000.
Salary sacrifice – net pay method
You will receive up to 45% tax relief (based on your taxable earnings). This is provided you have invested into your workplace pension using salary sacrifice.
Direct contributions (private pension)
The government will add up to 20% of your pension contributions if you have invested into a private pension directly. You will need to claim the additional 20% (for higher rate taxpayers) / 25% tax (for additional rate taxpayers) on yourself-assessment.
Mortgage interest relief solution – incorporation of your property portfolio into a limited company
We have written a separate article on how to incorporate your property business into a limited company. The laws relating to the Ramsey 2013 case at the Upper Tax Tribunal are as follows:
- 162 of the TCGA 1992 (for the CGT incorporation relief)
- 15 land and buildings FA 2003 (for the SDLT relief)
The process to move the properties into a simple/ordinary partnership. This is not to be confused with either a Limited Partnership or Limited Liability Partnership. After three years of operating as a partnership, you could incorporate into a company tax structure.
Please note that the stamp duty charge is voided (ie never payable) by you following the below process however the CGT is simply deferred under S162 incorporation relief.
The Ramsey Case
The Ramsey case highlighted the critical things that enabled the partnership to be classified as a business:
- 1 partner working in the Partnership for the majority of the working week (for the Ramsey’s this was 20 hours a week by Mrs Ramsey). Although 20 hours is not a strict number rather than a qualitative measure.
- 1 partner securing the majority of their income from the Partnership profits
- 1 partner managing all the letting management activity and ongoing building maintenance and never using a letting agent
On a more basic level in order for there to be a partnership, there need to be two people working together in a commercial business environment to make money (ie not a hobby business). A partnership agreement also needs to be in place (discuss this with a solicitor to make sure it is drawn up effectively). One person at the very least needs to be in the partnership business managing existing properties. Any work attending networking meetings and seeing new properties will not count. One person in the partnership business will need to manage the tenants, not using letting agents. One person in the partnership business must be responsible for sorting out maintenance work directly with tradespeople, again not using agents.
As I am sure you can see that there are many ways in which you can mitigate the impact of section 24 mortgage interest relief cap. It is worth speaking with your property accountants to see which of the above options work for you.
Mortgage editor’s comments
If you’re a buy-to-let property investor looking to mitigate your income tax, it’s essential to understand the implications for your future mortgage eligibility – whether for residential lending or personally held buy-to-lets.
Some tax strategies can impact on your ability to add to your portfolio, with even legitimate income changes throwing up red flags for lenders – ultimately leading to declined mortgage applications.
Before pushing ahead with a particular tax mitigation approach, check first with a specialist tax consultant – like our friends here at Optimise – to see what other options might be available to you.
After this, speak to a specialist mortgage broker – like the team at SPV Company Mortgages – to make sure your preferred tax options are compatible with lending policy. You don’t want your actions today to stand in the way of remortgaging and/or growing your property portfolio in the future.
Get in touch with our buy-to-let mortgage specialists and find out if your tax strategy is the right fit for your future property investment plans.
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