Buy to regret?

The first change is an additional 3 per cent stamp duty land tax (SDLT) charge on acquisitions of residential properties if the purchaser owns two or more such properties at the end of the day on which the acquisition takes place. The higher rates will apply to contracts exchanged after 25 November 2015 and completed on or after 1 April 2016 and are shown in the table below.

Table A

*This 0 per cent rate only applies if the total purchase consideration does not exceed £40,000

Those considering buying a property in Scotland (instead of England, Wales or Northern Ireland) will be disappointed, as there are plans to incorporate similar provisions into the land and buildings transaction tax (LBTT) applicable to residential property purchases north of the border.

Example 1

Example 1 shows the impact of the increased rates of SDLT on a property purchase of £200,000: If the purchaser then charged a tenant rent of £1,000 per month, the additional SDLT would be half the rental income earned in the first year.

The higher SDLT and LBTT rates will not apply where the purchaser owns only one residential property – anywhere in the world – at the end of the day of purchase. Therefore, an individual who lives in, for example, rented or employer-provided accommodation and acquires a BTL property would not be subject to the higher rates if he or she did not own any other residential properties. The higher rates will also not apply where the purchaser is replacing his or her main residence (that is, where a previous main residence was sold at any time in the 18 months up to the date of purchase).

As currently proposed, the SDLT rules in particular apply harshly to joint purchasers, married couples, civil partners and members of business partnerships. In each case, where one of the parties already owns residential properties, this will taint the treatment of a purchase by any of their ‘related’ parties. The following examples illustrate this point, although it should be noted it is possible that amendments may be made to these rules before they are enacted.

Example 2: B and C are purchasing a residential property together. This will be B’s first property, but C owns another residential property that she is not selling. For C, this will be an additional property as, at the end of the day of the transaction, she will own two properties and is not replacing a main residence. Therefore, the higher rates of SDLT will apply to the joint purchase.

Example 3: Mr A is a member of the Z Partnership. The partnership owns a number of residential properties which Mr A has a shared interest in. If Mr A purchases a residential property in his own name (other than to replace his main residence) he will be subject to the higher rates of SDLT on this purchase.

It is also proposed that the first property purchase by a company or collective investment vehicle will be subject to these higher SDLT rates. This is to prevent such vehicles being used to escape the higher rates.

Planning for the higher SDLT rates: If you have exchanged contracts after 25 November 2015 on a purchase that would be subject to the higher SDLT rates, it is important where possible to complete the purchase before 1 April 2016. For this reason, conveyancers are likely to be especially busy towards the end of March. Some individuals may consider transferring properties into a company before 1 April 2016 to protect against future SDLT charges. This is considered further below.

Relief

Restrictions on interest relief for landlords: From 6 April 2017, deductions currently available to individuals, property partnerships and trusts for interest and incidental finance costs against rental profits from residential property will be phased out over four years, disappearing entirely after 6 April 2020. These changes have already been enacted through the second 2015 Finance Act.

The deductions will be replaced by a reduction in income tax for the taxpayer concerned equal to 20 per cent of the lower of:

• the finance costs not deductible from income in the tax year (25 per cent of such costs will not be deductible for 2017/18, 50 per cent for 2018/19, 75 per cent for 2019/20 and 100 per cent thereafter);

• the profits of the property business in the tax year; and

• the taxpayer’s total income (excluding savings income and dividend income) that exceeds the personal allowance and blind person’s allowance in the tax year.

Any excess finance costs may be carried forward to following years if the tax reduction has been limited to 20 per cent of the profits of the property business in the tax year.

Losing interest deductions could, in some cases, cause taxpayers to move up into the next marginal rate of income tax.

Example 4: An individual earns £40,000 income per year from renting out residential properties. His annual mortgage interest on the properties concerned is £18,000. The other annual expenses of his property rental business total £7,000, so his annual rental profit is £15,000. He also earns employment income of £130,000.

Under existing rules for 2015/16, his total net income would be £145,000, on which he would pay tax, see Example 4A.

Example 4A

Under the new rules, from 2020-21, his taxable income would be £163,000. Applying current 2015/16 income tax rates and bands, his income tax liability would be calculated, see Example 4B

Example 4B

The extra £4,250 tax per year is made up of a halving of the tax relief available for his interest costs (£3,600) and the effect (£650) of £13,000 profits being charged at 45 per cent rather than 40 per cent.

Planning for the reduced tax relief: Those potentially affected by the reduction in tax relief may consider the following courses of action in the run-up to 2017.

Reduce financing costs – interest rates have remained at historically low rates in recent years, so it has made financial sense to borrow to invest in appreciating assets. However, investors with spare cash may consider using these funds to pay off their BTL mortgages if the after-tax cost of borrowing exceeds the post-tax return on surplus cash.

Transfer properties – some taxpayers may consider gifting BTL properties to their spouses, civil partners or adult children, especially if the removal of interest charges from the rental profits calculation causes them to fall within a higher marginal income tax band. Is using a company a sensible option?

Some investors are considering transferring their existing property portfolios into a company, or making new purchases through such a vehicle. Unless transactions can be exchanged before 1 April 2016, this course of action does not help to reduce SDLT or LBTT liabilities, although the 20 per cent corporation tax rate (reducing to 19 per cent in April 2017 and 18 per cent from April 2020) and general availability of interest deductions makes this an attractive solution for realising rental profits.

Transferring existing properties into an owner-managed company can have capital gains tax (CGT) and SDLT implications. In some larger portfolio cases, incorporation relief will be available to defer any capital gain arising, but only if the individual can demonstrate that an ongoing business is being transferred, including the day-to-day maintenance and management of the properties and interaction with tenants.

These tax problems do not arise when making new acquisitions through a company, but the owner must consider when, and for what purpose, he or she will need the profits rolling up in the company. Dividend tax rates increase from April this year, although the £5,000 annual dividend allowance will help those with single properties or small portfolios. New anti-avoidance rules due to come into force on the same date could also cause profit extraction, typically on the liquidation of such a company, to be taxed at dividend rates when they were previously dealt with under CGT.

Finally, the annual tax on enveloped dwellings applies from April 2016 to residential properties worth more than £500,000 (previously over £1m) held in companies and collective investment vehicles, with annual charges starting at £3,500. An exemption applies to properties held for the purposes of a property rental business but returns and claims are still required.

Example 5: This table in this example compares the annual tax cost from 2020 of carrying out the property business set out in Example 4 through a company or in the individual’s own name. Again, it assumes that income tax rates and bands stay the same and that the individual has an annual salary of £130,000.

Example 5

Wear-and-tear

Currently a generous wear-and-tear allowance is available for furnished residential accommodation. This broadly provides a tax deduction of 10 per cent of annual rental income. The Government intends to remove this allowance from April 2016 and replace it with a relief for the costs of replacing existing furniture. In most cases, this will be less generous than the existing wear-and-tear allowance.

Further clarity on how the increased SDLT rates will apply should be available following this year’s Budget on 16 March. This leaves very little time before these rates are expected to come into force. Current and prospective landlords should therefore already be planning for the future.

As the above examples demonstrates, tax benefits may be achieved by holding properties in a company, but the potential tax, administrative and professional costs should always be borne in mind.

Adrian Benosiglio is a tax partner at audit, tax and consulting firm RSM

Key points

Two major tax changes and one small change take effect, affecting buy-to-let landlords.

There will be an additional 3 per cent stamp duty land tax (SDLT) charge on acquisitions of residential properties if the purchaser owns two or more such properties.

Some investors are considering transferring their existing property portfolios into a company.