Buy-to-let  

A bitter pill for landlords

A bitter pill for landlords

The impending changes to the taxation of income from residential buy-to-lets (BTL) will hit higher-rate taxpayers hard.  

Effectively, the change is from tax on profits to tax on turnover – a controversial shift in the process of how tax works.  

This is part of the legal challenge being pursued through the courts to declare the new regime unlawful. BTL landlords are too easy a target, politically and economically, for the government to give up, so we expect to see the changes implemented in some form, even if the current approach is overturned.

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The mechanics are subtle but significant.

The effect of this can be seen in the example in Table 1, based on a purchase of £650,000 with a £400,000 mortgage at 4.25 per cent interest and an annual income of £32,500. Annual running costs are 10 per cent of the rent: £3,250. Table 1 shows the position pre-April 2017 and how it will look once the new rules are fully in place post April 2020.  

Table one

Table 1

 

 

 

 

 

Pre-April 2017

Post-April 2020

 

Rent

 £32,500 

 £32,500 

 

Operating expenses

 £(3,250)

 £(3,250)

 

Profit after operating expenses

 £29,250 

 £29,250 

 

Finance costs

 £(17,850)

 

 

Profit after finance costs

 £11,400 

 

 

 

 

 

 

Tax at 40%

 £(4,560)

 £(11,700)

 

Profit after tax at 40%

 £6,840 

 £17,550 

 

 

 

 

 

Finance costs

 

 £(17,850)

 

20% tax credit on finance costs

 

 £3,570 

 

 

 

 

 

Net profit after tax

 £6,840 

 £3,270 

 

 

 

 

Between 2017 and 2020 there will be a phased introduction, but when the changes are fully in place there is the possibility of almost doubling the tax on a typical investment. In some cases this could result in a net loss, with the total of mortgage interest and tax taking more out of the investment than the rent brings in. Table 2 uses the same figures as Table 1, but shows what can happen if the operational expenses increase to £10,000. for example, if it is necessary to replace the central heating system. 

Table 2         

Table 2

 

 

 

 

 

Pre April 2017

Post-April 2020

 

Rent

 £32,500 

 £32,500 

 

Operating expenses

 £(10,000)

 £(10,000)

 

Profit after operating expenses

 £22,500 

 £22,500 

 

Finance costs

 £(17,850)

 

 

Profit after finance costs

 £4,650 

 

 

 

 

 

 

Tax at 40%

 £(1,860)

 £(9,000)

 

Profit after tax at 40%

 £2,790 

 £13,500 

 

 

 

 

 

Finance costs

 

 £(17,850)

 

20% tax credit on finance costs

 

 £3,570 

 

 

 

 

 

Net profit after tax

 £2,790 

 £(780)

Unlike commercial investments, the BTL mortgage market started with investors buying in their own names mainly to supplement their pensions, especially where saving in a traditional pension is restricted, and there has been little incentive to change.  

Now the mood has shifted. Corporate structures are not affected by this fiscal earthquake, and we are now seeing landlords looking to move personally held BTL portfolios into limited companies. Lenders seem more willing to lend into this market and it suits the owners to take advantage of the differential tax treatment.

At present, it may be possible to make this move in a way that is tax-neutral for capital gains tax and stamp duty land tax, but there are traps for the unwary.

For best effect the portfolio must move from a property investment partnership to a limited company owned by the same owners. The new company will issue shares to the investors in exchange for the properties, and no other payment or transfer will be made.

There are several pitfalls that need to be considered in this process and we explain some of the more significant issues below. First, for optimum tax relief, the properties must previously have been held in a property investment partnership (PIP). Problems arise where the property is held by a single individual, or where the property is a passive investment.