Over 11 million UK residents have to complete their Self-Assessment tax return for the 2017/18 tax year by 31st January 2019. For many, the need to complete a self-assessment return is due to the additional income received from buy-to-let properties.
Paul Bonetti reflects on how recent tax rule changes are affecting buy-to-let property investments. Completing your tax return helps to assess the value of these investments and how they are contributing to your wealth.
Some people become landlords as a result of inheriting a property or starting a relationship with a partner where both partners own a property and then move jointly into one property and rent out the other.
Changing tax rules for second properties
Higher and additional rate mortgage interest relief is being phased out and from 2020/21 interest relief will be limited to the basic rate of 20% for all rental property owners.
How are the changes being phased in?
Prior to 6th April 2017 | 2017/18 | 2018/19 | 2019/20 | |
Percentage of additional and higher rate relief available | 100% | 75% | 50% | 25% |
These tax rule changes mean that there is less tax relief on mortgage interest for second property owners, but it will only impact you if you have a buy-to-let mortgage and are a higher rate or additional rate taxpayer. But don’t forget that rental earnings may take your income above the basic rate tax threshold.
This table provides an example of how these tax changes may impact a rental income of £10,000 per year on a second property:
Old rules | Transitional rules | New rules | |||
Pre 6.4.2017 | 2017/18 | 2018/19 | 2019/20 | 2020/21 | |
Rental income after deduction of allowable costs | £10,000 | £10,000 | £10,000 | £10,000 | £10,000 |
Interest on mortgage | £7,500 | £7,500 | £7,500 | £7,500 | £7,500 |
Pre-tax profit | £2,500 | £2,500 | £2,500 | £2,500 | £2,500 |
Interest now taxable | £0 | £1,875 | £3,750 | £5,625 | £7,500 |
Taxable profit | £2,500 | £4,375 | £6,250 | £8,125 | £10,000 |
Tax charge | £1,000 | £1,750 | £2,500 | £3,250 | £4,000 |
Less 20% tax credit | £0 | -£375 | -£750 | -£1,125 | -£1,500 |
Tax payable | £1,000 | £1,375 | £1,750 | £2,125 | £2,500 |
Profit after tax | £2,500 | £1,125 | £700 | £1,000 | £0 |
Second properties are subject to additional 3% Stamp Duty Land Tax (SDLT) on purchases. Some have unwittingly fallen victim of the 3% SDLT surcharge as they are looking to buy a new main residence, perhaps with a new partner, but they already own a rental property. For example, the stamp duty for a property worth £400,000 would increase from £10,000 to £22,000. If you find yourself in this situation, you should consider whether it’s worth keeping your existing property or selling it and investing your capital elsewhere.
Exploring the options:
Buy-to-let property owners face the choice of:
- Continuing as a landlord and monitoring the costs and returns; you need to consider repair costs and any gaps in tenancy, and your time, particularly if you choose to manage the property yourself. To improve your returns on your investment you could consider either increasing the rent, although this may make the property uncompetitive, or reviewing your existing costs which may include review of your mortgage review or property rental management fees by considering taking on the management yourself. However managing a property yourself may not be viable due to location and is likely to require your own time and cost.
- Selling the property; A sale of a second property is subject to Capital Gains Tax (CGT) at 18% (for basic rate taxpayers) or 28% (for higher or additional rate), 8% higher than CGT on other assets. The sale of your main residential property is not subject to CGT.
- Setting up a limited company to own the rental property, which will mean that the property is subject to lower company tax rates, but you will need to pay Capital Gains Tax and stamp duty when moving them into a property company.
- Transferring ownership to reduce tax. You may be able to reduce the tax payable on profits by transferring ownership to a spouse or civil partner who is a basic rate tax payer. This might, however, trigger Stamp Duty charges as the transfer is treated as a property sale. It is important to remember that the additional rental income may push the spouse/civil partner into a higher tax band.
The tax changes that the Government have recently introduced only apply to residential property, so investing in a commercial property could be a way to avoid the new CGT rates and loss of higher rate tax relief on mortgage payments. However there can be significant risks in choosing to invest in commercial property as an alternative to buy-to-let. It may be much harder to get a mortgage for a commercial property, higher borrowing interest rates may apply and the commercial market has seen widespread empty tenancies on the high street.
How can we help?
If you are an existing buy-to-let investor, you need to review whether the property continues to give you the level of returns you need and provides a profit. How do these returns compare with other investment opportunities? We can help you invest your rental income as well as helping you to consider how these buy-to-let changes affect your financial plans and help you to review your options.
Direct ownership of investment property is increasingly complex and subject to legislation changes. Please note that we are not tax specialists, but we will be able to refer you to experts in this area, if required. Our Origen advisers can help you to put the rental income to best use to help you towards your financial goals whilst also ensuring that you can meet the associated costs such as tax on the rental income.
This artical is for information only, based on our understanding as at January 2018 and is not to be taken as Financial Advice.
CA4049 Exp 02/2020
