Sunset on Buy to let? – Part 2

by | Sep 10, 2015 | Uncategorised

The extra summer budget this year included a second measure, which will be brought in gradually, and has the power to increase the effective rate of tax on your rental income to over 100%! These changes are being brought in over several years, starting in 2017, which probably reflects quite how serious they are. What follows discusses the envisaged final treatment – the destination, not the journey. The changes are scheduled to be completed by 2020.

Mortgage interest is currently allowable against the income from a buy-to-let property. It will continue to be, but only at the basic rate. Consider a higher rate (40%) tax payer, who currently has on top of his other income, rental income of £20k, falling in the higher rate band, with mortgage interest of £16k to relieve against it. He currently makes a property ‘profit’ of £4k, and pays tax of £1,600 on this (£4k at 40%).

On the new rules, his £16k of interest is restricted so as in effect only to be allowable at 20%, not 40%. So his taxable income is still £20k, his interest relief is now only £8k, and his taxable profit £12k. His tax bill is therefore going to be £4,800, when his ‘real’ profit is still only £4,000 – an effective tax rate of 120%! The options for someone in these circumstances are wide. He could put his property into a company, share the income with a spouse, or try to negotiate a better long term interest rate to compensate. He could even consider in investing in commercial property instead – it’s not affected by these changes. But all these actions will have wider implications – both tax-wise and in other areas. It will be sensible to take advice in the coming months as picture becomes clearer.

Unusually for this budget, this measure may have a smaller impact on contractors than others. A low salaried contractor will normally have property income taxed at the basic rate, and therefore would be no worse off if all of their property ‘activity’ falls in this band. We shall have to check the small print though when the legislation is passed.

A final thought – if the tax on residential property investment is increasing, then the government presumably hopes that this will lessen heat in the market and keep price acceleration under control at the lower end – starter homes and apartments. However, might not landlords try to increase rents a little to compensate? If so, would that not be likely to contribute to an increase in the price of these properties? If we add on the effect of interest rate changes (with interest only partially relieved against income), and the time period of the changes, it’s going to be almost impossible to see what impact overall, the changes will make. Except in the short term at least, to increase the tax take.

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Please note: JSA are not authorised to provide investment advice.  The notes above are discussion of the expected tax impact of changes announced by Government. If you require investment or more general financial planning advice, you should speak to an Independent Financial Advisor.  JSA work in partnership with Charles Cameron Financial Planning LLP, who are able to give this type of advice. Please mention us if you speak to them.

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