The Chancellor has dealt buy-to-let landlords something of a ‘triple whammy’. The first blow was dealt in the summer 2015 Budget, when the Chancellor revealed plans to restrict tax relief for finance costs to the basic rate of tax. This was followed up at the autumn 2015 Statement by two further blows – the intended introduction of a 3% stamp duty land tax (SDLT) supplement on second and subsequent residential properties, and a proposed future reduction in the capital gains tax (CGT) payment window for disposals of residential property to 30 days.
Blow 1 – Restriction in tax relief for finance costs
Under the rules as they currently apply, landlords are able to deduct finance costs from their rental income in arriving at the taxable profits of their property rental business. In this way, relief is given at the taxpayer’s marginal rate of tax. Thus, if the landlord is a basic rate taxpayer, relief is given at 20%; if the taxpayer is a higher rate taxpayer, relief is given at 40%; and if the taxpayer is an additional rate taxpayer, relief is given at 45%. Finance costs include mortgage interest (but not the repayment element of the payment where the mortgage in question is a repayment mortgage), and any incidental costs of obtaining the loan finance.
However, from 2017/18 changes are being phased in, which will change the way in which relief is given for interest and other financing costs. The changes will facilitate a switch from giving relief by deducting the finance costs in computing profits to a system where relief is given by means of a basic rate tax reduction. This means that an amount equal to 20% of the finance costs is deducted from the tax payable. In the transition period, the finance costs are split so that some relief is given by deduction and some by means of a tax deduction, with the pendulum swinging from relief fully by deduction in 2016/17 and earlier years to relief only as a basic rate tax reduction from 2020/21 onwards. In this way, relief at higher and additional rates will be phased out.
The transition will work like this:
- for 2016/17 and earlier tax years, all finance costs are deductible from income;
- for 2017/18, 75% of finance costs will be deductible from income, and relief for the remaining 25% will be given as a basic rate tax reduction;
- for 2018/19, 50% of finance costs will be deductible from income, and relief for the remaining 50% will be given as a basic rate tax reduction;
- for 2019/20, 25% of finance costs will be deductible from income, and relief for the remaining 75% will be given as a basic rate tax reduction; and
- from 2020/21 onwards, relief for all finance costs will be given as a basic rate reduction.
Example 1 – What this means for landlords
Greg has a buy-to-let portfolio. He receives rental income of £60,000 a year. He pays mortgage interest of £20,000 a year and has other deductible expenses of £5,000 a year. It is assumed that he has other income which utilises his personal allowance and basic rate band, and the income from property is taxed at 40%.
2016/17 2017/18 2018/19 2019/20 2020/21
Rental income £60,000 £60,000 £60,000 £60,000 £60,000
Deductible interest £20,000 £15,000 £10,000 £5,000 £0
(100%) (75%) (50%) (25%)
Other expenses £5,000 £5,000 £5,000 £5,000 £5,000
Taxable profit £35,000 £40,000 £45,000 £50,000 £55,000
Tax on profits (@40%) £14,000 £16,000 £18,000 £20,000 £22,000
Income tax
Reduction £0 £1,000 £2,000 £3,000 £4,000
(£5,000 (£10,000 (£15,000 (£20,000
@ 20%) @ 20%) @ 20%) @ 20%)
Total tax payable £14,000 £15,000 £16,000 £17,000 £18,000
Amount retained £21,000 £20,000 £19,000 £18,000 £17,000
As a result of the restriction of relief, Greg’s tax bill increases from £14,000 in 2016/17 to £18,000 in 2020/21, and the amount that he retains from his rental income (after paying tax, expenses of £5,000 and mortgage interest of £20,000) drops from £21,000 to £17,000.
Trap:
At first sight, it may appear that basic rate taxpayers are unaffected by this measure. However, the switch from relief by deduction to relief as a tax reduction increases the taxable profit and this may be sufficient to push the landlord into the higher rate tax bracket. The increase in taxable profits resulting from this policy change may also have other knock-on effects, such as triggering the high income child benefit charge, or reducing entitlement to tax credits. In the above example, although the interest costs, rental income and expenses remained unchanged, Greg’s taxable income increased from £35,000 in 2016/17 to £55,000 in 2020/21, purely as a result of the change in the way in which relief is given.
Blow 2 – 3% SDLT supplement
The second blow is the intended introduction of a 3% SDLT supplement, which is to be charged on most second and subsequent residential homes. It will apply from 1 April 2016, and is the first of the measures to hit landlords etc. to take effect. Under the proposals, further details of which are set out in a consultation paper published in December 2015, higher rates of SDLT will be charged on purchases of additional residential homes, such as buy-to-let properties and second home. The higher rates will apply to second and subsequent residential properties costing more than £40,000. The higher rates will be 3% higher than those currently applying to residential property. The rates are summarised in the following table.
First residential Second and subsequent residential properties – from 1 April 2016
On first £125,000 0% 3% (but no SDLT payable if property costs less than £40,000)
Next £125,000 (£125,001 to £250,000) 2% 5%
Next £675,000 (£250,001 to £925,000) 5% 8%
Next £575,000 (£925,001 to £1.5 million) 10% 13%
Remainder above £1.5 million 12% 15%
Example 2 – Impact of the SDLT supplement
Ruth has three investment properties which she lets out in addition to her main residence. She inherits some money and wishes to invest in a further property to let out, eventually finding one in January 2016 costing £275,000.
If she completes before 1 April 2016, she will not pay the supplement and will pay SDLT of £3,750 ((£125,000 @ 0%) + (£125,000 @ 2%) + (£25,000 @ 5%)).
However, if she completes after 1 April 2016, she will be liable to the supplement and will pay SDLT of £12,000 ((£125,000 @ 3%) + (£125,000 @ 5%) + (£25,000 @ 8%)).
Completing after 1 April 2016 will increase the stamp duty payable by £8,250 (being £275,000 @ 3%).
Tip:
Those planning to buy second homes and buy-to-let properties should complete by 1 April 2016 where at all possible, as the SDLT savings could be significant.
Under the proposals set out in the consultation document, the higher rates will not apply where the main residence is replaced, even if the purchaser owns more than one residential property once the transaction is complete. If there is a delay in selling the original main residence (such that for an overlap period both the old and new main residences are owned), the higher rates will initially apply, but the difference between the higher and normal rates will be refunded if the original main residence is sold within 18 months.
It is also proposed to introduce an exemption from the higher rates for corporate and funds with at least 15 residential properties.
Blow 3 – Reduced CGT payment window
At the time of the Autumn 2015 Statement, the Chancellor also revealed plans to reduce the payment window for CGT in respect of gains on property disposals to 30 days.
Currently, CGT is payable by 31 January after the end of the tax year in which the disposal tool place – allowing a payment window of up to 22 months. Under the proposals, on which the Government will consult in 2016, a payment on account of capital gains on the disposal of a property will be required within 30 days of the date of the disposal. The measure is due to take effect from April 2019.
Practical Tip:
Landlords should assess the impact of these changes on their property portfolios, so that they can plan ahead.
