With tax returns for 2017-2018 now being submitted ahead of the end of January deadline, these will be the first to include the staggered removal of mortgage interest tax relief on rental income.
Consequently, many of those returns will result in a larger than expected bill for some of your clients.
In last month’s column I discussed the potential solution of using a limited company to address this situation.
This month I spoke to Alex Bari, tax partner at Barnes Roffe LLP for an expert view of what the tax changes could mean for your clients and their plans.
JL: Which landlords can expect a larger tax bill this year, and by how much are their bills likely to increase?
AB: Individual residential landlords with mortgages on their properties will be affected if they are higher or additional rate taxpayers or pushed into higher or additional rates by the new mortgage interest relief restriction rules.
The first year that the rules came into effect was for the year ending 5th April 2018. However, as the due date of tax for said year is 31st January 2019, people will be feeling the pinch for the first time soon.
It is difficult to quantify the increase as it depends on a number of factors, however, as a rule of thumb:
- Higher rate taxpayers will pay additional tax equivalent to 5% of their interest cost and additional rate taxpayers will pay additional tax of the equivalent of 6.25% of their annual interest cost for the year ended 5th April 2018.
- The above could be worse for some people if they are pushed into the higher or additional rate tax bands by the mechanics of the above rules or it causes them to have their personal allowance tapered away.
JL: Will their bills increase further in the coming years and by how much?
AB: Yes, again as a rule of thumb Higher Rate taxpayers will pay 10% of their interest as additional tax in 2018/2019, 15% in 2019/2020 and 20% in 2020/2021.
Additional rate taxpayers will pay 12.5% in 2018/2019, 18.75% in 2019/2020 and 25% in 2020/2021.
Again, the numbers could be higher if the individual is pushed into a higher tax band or their personal allowance is tapered away.
JL: What are some of the steps they can take to reduce their tax bill and what are the considerations?
AB: Every case is different and will require tailored advice.
One option buy-to-let investors could consider is incorporation (transferring their properties to a limited company in exchange for shares) as the new restriction does not apply to companies.
Additionally, rates of Corporation Tax (currently 19% and moving to 17%) are lower than income tax (which is 20%, 40% and 45%, depending on the tax bracket).
Incorporation can, in some circumstances, be achieved without triggering Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT).
However, the default position is that the properties are transferred into the company at market value and will trigger a disposal for CGT and a purchase at market value for SDLT.
Investors could also consider forming a limited liability partnership (LLP) with a limited company and the corporate partner’s profit share would not be subject to the interest relief restriction rules.
However, the mixed partnership rules severely limit the profit allocation which can be attributed to the corporate member, so the effectiveness of this is hampered.
JL: It seems clear that, while there are some well-publicised options for buy-to-let investors, the best approach will depend on their individual circumstances.
There is therefore an important role for specialist property tax advice and, for brokers, now is the time – if you haven’t done so already – to establish a referral relationship so you can be confident that your clients are best placed to weather the storm of increasing tax bills.