Buy-to-let tax changes – do you know how to make the most of your investment?
Following a number of varied and confusing tax changes introduced of late, landlords are becoming increasingly concerned about their property investments.
In April, Chancellor George Osborne imposed a three per cent Stamp Duty Land Tax (SDLT) surcharge upon second homes – which went hand-in-hand with complicated changes to wear and tear allowances and new reporting requirements for Income Tax and Capital Gains Tax (CGT) purposes.
HM Revenue & Customs (HMRC) reeled in a record-breaking £1.2billion in Stamp Duty in April, from a total of 173,430 property transactions – as landlords and investors settled their tax bills following the so-called ‘buy-to-let rush’ in March.
However, The Bank of England predicts that “rampant demand” for buy to let investments will continue, and a separate survey conducted by finance providers recently revealed a rise in the number of landlords who are planning on expanding their portfolios in coming months.
Stamp Duty Land Tax
Since April, the additional 3 per cent band has normally been charged on any home purchased if the buyer ends up with more than one property — the purchase of a buy-to-let property or holiday home being the two obvious cases.
On a £500,000 property this equates to £15,000 on top of the £15,000 tax you would already be paying. For a £1,200,000 home, Stamp Duty would be £63,750 if it was a first home. For a second property this rises to £99,750.
However, the government made an exemption for people who had more than one home but were replacing their main residence. So if a landlord or someone with a holiday home sold the home that they actually lived in, and then bought another property to replace it as their main residence, they would not be subject to the 3 per cent surcharge on the new property.
An increase in the rent-a-room allowance
Anyone who rents out a furnished room to a lodger where the rental income exceeds £7,500 a year must pay tax on the amount above this. It used to be £4,250 and the threshold moved for the first time on April 6 since 1997.
If your rental income goes over that amount you will have to fill in a tax return. And there is a fine line between taking in occasional B&B guests and running a business.
The move will mean the majority of lodger landlords will avoid paying tax altogether. Lodger landlords can earn, on average, £8,335 a year in London, and £6,071 across the rest of the UK, according to website Spareroom.
The abolition of the wear and tear allowance
Landlords who rent out furnished homes used to be able to claim tax relief on 10 per cent of their rental profits even if they do not do any work. This wear and tear allowance was abolished in April.
However, it has been changed to a new replacement furniture relief, which is for all landlords of fully furnished property, other than furnished holiday lets.
The new replacement furniture relief
Tax relief is given against landlords rental income for:
- The cost of the replacement item
- Less the cost of any element of improvement (beyond the nearest modern equivalent)
- Less any proceeds of sale of the old item
- Plus any costs of disposing of the old item
Relief is given for ‘domestic items’ which includes:
- Moveable furniture
- Furnishings such as carpets, curtains and linen
- Household appliances such as fridges and freezers
- Kitchenware such as crockery and cutlery
Items must be provided solely for the use of the tenant within the residential property.
Fixed items such as baths or boilers already attract relief as being a repair to the property itself.
Any element of expenditure which represents an improvement will not attract relief. For example, replacing a fridge with a fridge freezer carries an element of improvement. Therefore, no relief is available for the additional cost attributable to the freezer element.
The gradual restriction of higher rate income tax relief for finance costs
The change which will have the greatest impact is the gradual restriction of higher rate income tax relief for finance costs, which includes a landlord’s major cost, mortgage interest.
As a direct result of this one change, landlords who have borrowed heavily to grow their property portfolio may find themselves paying income tax at higher rates. They will need to work out the impact on their future tax payments and take the necessary steps to maintain the sustainability of their property business.
Action needs to be taken before April 2017.
If you have properties that have significant mortgages or loans you will likely be paying an increasing amount of income tax from April 2017.
The restriction of income tax relief will apply to individuals:
- Who let residential property in the UK or elsewhere, and
- Who are claiming a deduction for financing costs from April 2017,
- Who, from April 2017, pay income tax on their property income at the higher (40 per cent) or additional (45 per cent) rate.
It will not apply to:
- Financing costs for purchase of furnished holiday let or commercial property,
- Property businesses subject to corporation tax – owned by companies, or
- Individuals who pay tax on their property income at basic rate only.
The new measure will gradually restrict landlords’ tax relief for finance costs to purchase residential properties, to the basic rate of income tax. From 6 April 2020 landlords affected will no longer be able to deduct their finance costs from their property income. Instead they will receive a basic rate deduction from their income tax liability.
Because the amount of tax relief is gradually reduced, from April 2017 to April 2020, the cash flow impact is progressively negative for higher rate or additional rate tax payers.
A further consequence of this change to a basic rate deduction is that the rental income for tax purposes increases with no increase in rents: the finance costs are added back. In some circumstances this may mean that basic rate taxpayers become higher rate tax payers.
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