Previously, buy-to-let property owners were able to claim relief on mortgage interest payments at their highest marginal rate of tax (up to 45 per cent). However from April 2017, relief will only be able to be claimed at the 20 per cent basic rate of tax – albeit phased in over a four-year period.
For those with financing against rental properties, this reduction in the allowable level of tax relief could have a very significant impact on profits in the years ahead.
This article examines the possible effects of these changes and considers some Financial Planning options that our clients with buy-to-let property portfolios might wish to consider.
Do the new rules impact all properties?
No. These new rules do not apply to owners of furnished holiday lets or to landlords of rented commercial property.
How will the new rules be phased in?
As the table below shows, the transition from being able to claim relief on mortgage interest payments at the additional rate (45 per cent) to the basic rate of tax (20 per cent) will be phased in over a four-year period, starting from April 2017:
What might the impact of these changes look like in financial terms?
The following table considers a property portfolio worth GBP5 million, yielding a rental income of 4 per cent per year, and where the current and future positions are compared in three scenarios: 65 per cent mortgaged, 40 per cent mortgaged, and no mortgage. The property owner is assumed to be a 45 per cent taxpayer before receipt of the rental income.
- It is evident from the scenarios above that buy-to-let owners whose property portfolios are the most highly leveraged will suffer the greatest impact to their profitability from April 2020/21 onwards
- The removal of the interest relief as a deduction against rental income could have a major impact on an individual’s tax rate. For example, if an individual had debt against a property and assuming this was the only source of income, the individual could be a 40 per cent taxpayer in 2016/17 with minimal loss of personal allowance - but in 2020/21 that person could become a 45 per cent taxpayer with no personal allowance
- With the announcement in the 2016 Budget that residential property owners will not benefit from the reduced rate of Capital Gains Tax (10 per cent for basic rate taxpayers and 20 per cent for higher rate taxpayers) but that gains realised from the disposal of residential property will continue to be subject to the 28 per cent rate, has the attractiveness of holding residential property as an investment asset diminished when compared to other financial assets?
Do you have any planning options?
Incorporation of rental business: Buy-to-let property owners may wish to consider the benefits of incorporating their businesses to a UK Ltd company as the limitation of interest relief only applies to individuals. There are, however, various complicating factors that would need to be considered with your accountant before undertaking any actions including:
i) stamp duty and capital gains tax implications.
ii) tax would be payable (in addition to corporation tax) on the extraction of any profit.
Reducing loans held against residential property: As can be gleaned from the illustrations above, buy-to-let property owners with higher amounts of leverage will be most impacted by these changes.
If reducing loans against property portfolios is an option, professional advice should be sought before doing so in order to assess the impact on your overall financial affairs.
At HSBC Private Bank, our Strategic Financial Planning team works with our clients and their advisors on a range of planning areas from Investment Structuring and Business Exits to Estate Planning and Family Governance.
Why not contact your Relationship Manager or Investment Counsellor to arrange a meeting to see how our Planning Specialists or Credit Advisors might be able to help you?