Section 24 – impact on landlords with mortgages.

Will I have to pay more tax as a result of Summer 2015 Landlord Tax announcement?

Key impact-Budget 2015/6 updates mean property investors will pay more tax!

One of the statements being banded around this budget announcement was that it will only impact ‘1 in 5’ landlords.  I said it then and it has since been proven that only those with ‘no mortgages’ and possibly some with very low rental incomes (ones who own a single rental property) may not be impacted by this budget announcement.

In the 2015/6 budget updates George Osborne put in place a number of tax changes, which will directly impact Property Investors and Landlords.  The three main changes are

Changes to mortgage interest relief.

The tax relief on mortgage interest will be set at 20% even though you might be a higher rate taxpayer. In essence, this means that, as an example, if you have mortgage interest costs of £6,000 it will be reduced to £3,000 as an allowable cost to offset against your income.

Removal of the 10% wear and tear allowance.

If you have furnished properties then you were previously able to claim 10% of the net rent. This has now been removed. As such if your rental income for furnished properties was £40,000 then you would lose the £4,000 allowable costs for wear and tear. There are way how you might take advantage of this change, which will be discussed later.

Increase is SDLT when purchasing additional property

There is an additional surcharge of 3% of the purchase prices when buying any BTL (or second property), whether as an individual or an incorporated identity.
One of the less discussed impact of this Budget Announcement is how some people who are currently basic rate taxpayers may soon be become higher rate taxpayers without any increase in income. This ultimately implies that a huge number of landlords will pay more tax on their property portfolio.

Let’s now discuss the real life impact of these changes and how can these be mitigated (in some cases).

The problem — the removal of the 10% wear and tear allowance
Previously your monthly rental accounts may have looked something like this:
+£2,000 rental income-£500 mortgage interest-£300 utility bills-£300 other costs-£170 wear and tear allowance (10% of the rent less utilities)

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Leaving £730 profit

Now that the 10% wear and tear allowance has been removed, your monthly profit has increased to £900, which leads to a yearly increase of £816 in tax for a higher rate taxpayer (£170 X 12 months X 40%). Ouch!

Ways to mitigate this increase in your tax

The budget change has removed the automatic entitlement to relief for an assumed amount of 10%, and replaced it with relief only for actual expenditure. It now allows costs to be deducted when you are replacing or repairing furnished items, but crucially, not the original cost of an item.  In the majority of cases, you will be buying properties which already have carpet and, perhaps, curtains. But what if you agreed a deal with the vendor that involved them leaving behind the furniture and white goods? I would think that some vendors may be keen to leave a lot of their furniture behind if it helps them to sell the property to you, particularly if they’re selling a rental property and have no need of the items themselves.

You can ask the seller to list all the items that will be left in the property and you must allocate a cost against each item to ensure that you maximise your tax relief. For example:
£125,000 house purchase£2,500 carpets throughout£1,200 curtains throughout£2,800 sofa and settees in lounge area£3,500 furniture (dining table and chairs, cupboards and wardrobes in bedrooms)Total purchase price including furnishings = £135,000

If you itemise the deal this way, then subsequently wish to replace any of the items because they look tired or you think the property needs a refresher, then the cost of the replacement items becomes allowable as a deduction that can be offset against your income. If you had bought the property without the furniture and fittings, then purchasing new ones would not be tax deductible.

There is also an added bonus…

Cut your stamp duty 

From April, Stamp Duty Land Tax (SDLT) will have two components for property investors. The normal residential SDLT charge and the 3% SDLT surcharge.
Imagine that you have agreed a price on the property above for £135,000. There would usually be two levels of SDLT to take into account:
£200 (2% of the difference between £135,000 and £125,000)

£4,050 (3% on the entire amount of £135,000)

£4,250 SDLT total

However, as we have seen from the previous example, the total price you pay to the vendor may be partly for the house and partly for the furnishings. If that’s the case, you can reduce the portion of the sale that is subject to SDLT. Let’s assume that you agree that the seller will leave all of the curtains, carpets and furniture items. You agree that these items should be valued at £10,000. The land and buildings cost has therefore been reduced to £125,000.

SDLT will therefore be re-claculated as:
£3,750 (3% on the entire amount of £125,000) – £3,750 SDLT

Hopefully, by now you can see there is an added benefit to negotiating the purchase of the fittings — you can reduce not only future tax, but also the SDLT payable on the sale.

Practical steps you should now take to reduce your tax liability

  • Agree a purchase price with the seller
  • Itemise the furnishings and fixtures on box 10 in form SDLT1
  • Keep a record of items that now sit in the property
  • Purchase replacement furniture items and offset the cost against your property income.

Impact of the Mortgage Tax Relief limitation.

If you are not already aware, the current use of interest paid on your mortgage and property loans as an Expense before calculating your profit will no longer be allowed from April 2021, if the challenge to this law is not successful (See end of this article).

The landlords are fighting to change this ill-judged piece of law as it treats the business of renting properties different from all other businesses where and interest paid on business loans IS a ‘business expense’ and is used deducted before calculating business income for tax purposes.  Moreover, even after this calculation, the mortgage interest is deducted as a Relief, hence increasing your ‘Apparent Income’, thereby changing your tax band (moving you into a higher band) for the purposes of Income Tax Calculation.  This implies that you could be paying a higher rate of tax even without any increase in your income.

See some examples below of how this change may move people from

  • Basic Rate to Higher Rate tax band,
  • Higher Rate to Additional Rate and also
  • the Loss of Personal Allowance for those earning above £100K.

For purposes of simplification, the personal allowance rates, Income Tax thresholds, etc have been kept static for the transitions period between 2016 and 2021.

See the spreadsheet at this link for example calculations.

To fight the tax, join

https://www.facebook.com/clause24

Credits – Some of the examples and text has been ‘borrowed’ from the very respected Simon Meisewicz of Optimise Accountants

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