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  • Overview

    The Chancellor, it seems, has taken a dim view of individuals taking advantage of low interest rates to buy property to rent out, and obtain income tax relief for the interest on borrowings used to purchase those properties.  The new rules, which will see tax relief restricted to the equivalent of basic rate tax on the finance costs of purchasing buy to let properties, are to be phased in over three years starting from 6 April 2017.  The full restriction will therefore apply to interest payments from 6 April 2020.

    Finance costs are not restricted to interest, but include premiums, discounts and the incidental costs of obtaining finance.  The changes will impact upon individuals, partnerships, trusts and estates.  It is a misconception to think that basic rate taxpayers will not be affected, as shown in the following example:

    Rigsby has a portfolio of residential properties generating an income, net of expenses before interest costs, of £90,000.  He pays interest of £50,000 per annum.

    In the current tax year 2015-16 he has a net income of £40,000 and after personal allowance pays tax of £5,880, all at basic rate.

    If the new rules had applied in full in 2015-16 he would have had a tax liability of £25,403 on income of £90,000, and have a tax reduction of £10,000, so paying £15,403.

    The way taxable income is calculated will therefore change and may impact on other areas of personal taxation, for example the high income child benefit charge.

    Furthermore, it does not apply to property development trades or to borrowings for trades that are secured on a let dwelling house.

    Where properties are owned in partnership or are jointly owned, each partner or joint owner receives the tax reduction equal to basic rate on their share of the disallowed interest costs.

    In cases where the tax reduction cannot be used in full during the tax year, the calculation will become more complicated, with any unused restriction being carried forward and used to increase the tax reduction available in the following year. For example:

    Miss Jones has pension income of £40,000 and a rental property generating income after expenses of £7,000.  She pays interest on borrowings of £10,000 per annum.

    Miss Jones’ tax liability before the tax reduction on loan interest amounts to £8,000.  The tax reduction is restricted to basic rate on property profits of £7,000 so her final tax bill will be £6,600.  Note that only £7,000 of the £10,000 finance costs have been utilised. 

    In the following year net property income before borrowings is £14,000.  The tax liability before the reduction for finance costs is £10,800, but the tax reduction is increased to £2,600 (£13,000 at 20%).
    As mentioned above, trustees and personal representatives are subject to the same restrictions as individuals.  Accumulation and discretionary trusts are entitled to the basic rate tax reduction in the same way, but trustees of interest in possession trusts and personal representatives need to be aware that the tax reduction applies to the life tenant or legatee.  More detail will need to be given on the tax certificates issued by trustees to beneficiaries receiving rental income payments. 

    While most trustees do not have borrowings, problems may arise if they do, and professional advice should be sought.

    However, there are many factors to be considered before making such a change in terms of income tax (especially with the introduction of the new rates of dividend tax from 6 April 2016), capital gains tax and Inheritance Tax.

    In addition to the changes in the tax relief available to residential landlords, with effect from 1st April 2016 higher rates of Stamp Duty Land Tax (SDLT), equivalent to 3% above the current rates, will apply to the purchase of additional residential properties above £40,000. Buy to let landlords and owners of second homes will have to ‘opt in’ to these higher rates by declaring that the property will not be their primary residence.

     

    Standard Rates

    Higher Rates (from 1 April 2016)

    Up to £125,000.00

    0%

    3%

    Above £125,000 up to £250,000

    2%

    5%

    Above £250,000 up to £925,000

    5%

    8%

    Above £925,000 up to £1,500,000

    10%

    13%

    Above £1,500,000

    12%

    15%

     

    By way of example, from 1st April 2016 an additional £5,520 of SDLT will be payable on a buy to let purchase of £184,000.

    The changes to the SDLT rates and tax relief on the purchase costs of buy to let properties will, no doubt, have a widespread impact on many residential property portfolios.  Residential landlords should start preparing now.  Please contact Kristina Mathieson for further advice on tax relief issues, and Sandra Manning for guidance on SDLT for residential property.

    If you would like to further discuss any of the information detailed above, please contact Kristina Mathieson on 01892 701232 or Sandra Manning on 01892 701227.

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