The previous Chancellor George Osborne decided that buy-to-let landlords were distorting the property market, making it more difficult for first time buyers. Therefore he introduced several changes to make buy-to-lets less attractive. We thought it would be useful to clients to share some of the ways in which we are advising. A recent legal challenge to the validity of these tax changes has just failed in the Courts – so we are now sure that these changes will come in.
The changes are:
- An additional 3% Stamp Duty Land Tax (“SDLT”) on second homes in addition to the normal SDLT paid on residential properties. This includes acquisitions by joint owners when only one has an existing property.
- Abolishing the tax relief of a notional 10% of rent for wear and tear in calculating the profits of furnished letting.
- Higher rate tax relief will be gradually withdrawn on interest paid on mortgages. This will give some clients a tax liability when they have no profit. E.g. if you earn £50,000 per annum and own a property rented for £15,000 then if your expenses were £3,000 and mortgage interest £12,000 then currently you pay no tax whereas you will when the rules change.
There are some specific transactions which are caught by the new rules which are surprising as they are not connected to the buy-to-let market.
We had a client who wanted to buy a property for £350,000 with her son to live in so that she would own 10% and he would own 90%. This has been a common arrangement to make first time buying easier for an adult child but providing the parent with some comfort that the child cannot squander the money by borrowing against the property. However she has her own home already and under the new regime the additional rate was due on the whole purchase price of the property £1,050. In the end she decided to pay the additional tax. However she could have structured it so she made a loan of £35,000 for a fixed short period – e.g. three months. He then had a choice to repay the loan or if he was unable to do so then he could transfer 10% of the property to her without any SDLT – provided the value remains below the de minimis limit of £40,000.
We also believe that couples planning to marry who already own property need to think carefully about whether they might look to buy another property and the possible SDLT consequences. If one spouse’s property is going to be sold to fund the purchase of a joint home and the others will be retained to rent – then there could be less SDLT if those transactions are carried out before the wedding rather than after.
Income tax issues
Looking at the income tax changes we already have clients who are looking to sell one or two properties from a portfolio to pay off mortgages and so eliminate the interest which will no longer fully qualify for tax relief. It also minimises financial risk to fluctuating property values.
If we were now talking to a client looking for a first buy-to-let property with a significant mortgage then we would certainly want to consider buying through a company which will then carry on a property letting business – since the new restrictions on interest only apply to individuals. In addition some clients will consider holding the property in the name of a spouse who is a basic rate taxpayer since this avoids or reduces the higher rate charge. Any structuring requires consideration of important matters other than income tax – e.g. financing cost or the capital gains tax on any increase in value. Fewer financial institutions will lend large sums to companies for property investment which could be critical. However for some people the ability to save tax in the short term to increase the funds to repay the mortgage will be the overriding factor. Anyone who is buying for the very long term will be less concerned about eventual capital gains tax and more about being able to generate an income in retirement. However, buying through a company will still mean that the additional SDLT will be payable.
We are actively considering the potential benefit which would be obtained by selling a small share of a property to a company, which is then entitled to a share in the rent. The amount transferred must be below the £40,000 SDLT limit to pay no tax. The company is then immediately liable to the rent on the share acquired – which may avoid higher rate tax. However this small saving can be augmented because HMRC instructions allow joint owners of a property to split the income in a way other than directly in proportion to the share of the ownership. So provided that it can be justified – e.g. by the company collecting the rent and accounting to the other owners – then perhaps another 15%- 20% of the rent could be added to the company’s share. This would reduce the income liable to income tax – and for some clients would take them out of higher rates.
Our initial feeling is that the saving probably does not justify setting up a company solely for this purpose – but many clients have a trading company which can be used. One client is actively considering this option because it appears to be an easy way to withdraw almost £40,000 cash from a company to buy a share in a property which they own personally without income tax that would be due on a bonus or dividend and so reduce the mortgage more quickly. There are other matters which would need to be considered – especially how you would propose getting the share of the property out of the company in the long term.
It may be possible to repeat the purchase of a small share in the property – either by buying more shares in the same property or buying a share in several properties from a portfolio. Care will be needed to avoid these being linked transactions for SDLT.
We are also considering whether for landlords with a significant number of properties that they might consider an initial transfer into a company – and then for the company to enter into a formal partnership with the owner. The commerciality of a partnership will need to be demonstrated but this might be a useful way to structure the business in some cases. We are looking to investigate whether this makes it easier for the banks to consider lending funds to the company rather than the individual.
The new income tax rules come into effect in April 2017 and they are being phased in over four years. Any clients who are concerned about the tax liability should contact their account manager to see if anything can be done.