100 Top Tips for Businesses - #19 Landlord Tax Rules
It’s potentially the biggest change to the property market in decades and landlords with multiple properties are taking flight, fearing the new tax rules that were introduced from April 2018 will evaporate any value from the investments they’ve built up through decades of hard work.
But, like every cloud, this one has a number of silver linings – in the form of alternatives for current landlords, and opportunities for would-be new ones.
Here, finance expert Darren Peacock of Hull-based Peacock Finance – a partner on our InspiringBusiness2018 campaign - guides you through the implications.
April 2018 marked the start of a change in the law which means landlords earning above the higher earnings threshold will no longer be able to claim tax relief on any mortgage interest they pay on properties they hold in their personal name.
The relief is being phased out in stages, reducing to 75 per cent this year, 50 per cent in 2019 and 25 per cent in 2020 – after which it will disappear altogether.
This means that, after 2020, landlords will pay tax based on their overall earnings on ALL property income. On a mortgage of £100,000, where a landlord is paying £400 on an interest-only mortgage and earning £600 in rent each month, they would only pay tax at their prevailing rate on the £200 profit under the old rules, equating to £40 per month for a lower rate taxpayer and £80 per month for a higher rate taxpayer. From 2021, they will pay interest on the full £600 rent, increasing their tax bill to £120 and £240 respectively, dissolving their income or, worse still, costing them money to maintain their property portfolios. Multiply that across a holding of, say, 100 properties and there is suddenly the potential to lose hundreds of thousands of pounds off their bottom rule that wouldn’t apply to any other type of business.
Darren said: “For the past two years since the changes were announced, I’ve been seeing a trend of portfolio landlords divesting themselves of their property.
“To me it does seem fundamentally unfair that what are essentially small businesses like any other, will no longer be able to offset their costs in the same way.”
This could also have far reaching implications for the housing market because, since the financial crisis, it is the landlords sector that has propped it up by mopping up any potential property over-supply which could have heightened the market downturn. They have also provided people with alternative homes, who would otherwise have been locked out by the market tightening.
The change in rules is an attempt by the Government to shake up the accidental landlord market and make property available to first time buyers instead.
Darren added: “However, the unintended consequence of that, in my opinion, is that the professional landlord sector serves a very different market, of people who don’t necessarily aspire to purchase their own home, and therefore the change in rules is likely to leave those people without housing options as professional landlords, too, decide to exit the market.”
If you own property as a limited company, the same tax breaks apply as with any small business and, at least under the current rules, you can offset your rental income against profit and tax. Corporation tax would apply instead of income tax, at the lower rates of 19 per cent now, reducing to 17 per cent by 2020.
“Because savvy landlords have known what’s coming, I haven’t had a single request for a buy-to-let mortgage in a personal name for over two years now,” Darren said.
As well as being the smart way to do things going forward, no more costs apply and the interest rates when buying as a limited company are the same as those for a loan secured in a personal name. Most of the criteria are the same, too, such as lenders usually requiring a minimum deposit of 25 per cent.
However, there are added advantages to buying as a limited company. Because of the changes in tax law, lenders are now typically asking for rental cover (the amount of rent a property is capable of generating) of 145 per cent of the mortgage payment for buy-to-let loans in personal names, whereas for limited companies it remains at 1.25 per cent.
Can you transfer any existing properties into a limited company?
Darren explained: “Unfortunately not. This is because you would have to transfer your property at its full market value, and so incur capital gains tax, eradicating any benefit. You would also have to pay a minimum of three per cent Stamp Duty (five per cent for property worth over £125,000), not to mention conveyancing fees, as you would be effectively selling the properties to your new limited company, making it financially unviable.”
There is a new precedent created by something called the Ramsey Ruling, which emerged in 2013, where a landlord in Scotland called Elizabeth Moyne Ramsay won her tribunal case for transferring all her properties into a limited company as a going concern, because it was her only form of income. However, this only applies where you can categorically prove that you do nothing else, and have no other income, than your properties.
“Even if you think this could apply to you, beware, because where HMRC was considering such instances on a case-by-case basis, it has now stopped doing so, meaning that anyone deciding to go down this route must effectively take a real gamble on achieving the right outcome in the end,” Darren cautioned.
“You could, of course, take the opportunity to sell any properties you already own personally, and buy a new portfolio as a limited company, in which case you would avoid capital gains tax but would be liable for Stamp Duty and conveyancing costs.”
As with all change, in this instance one landlord’s downside is another’s destiny and the fact that some tired landlords are opting to offload, means there’s a potentially golden opportunity for newcomers to acquire property for the first time at very competitive prices. Setting them up within limited company wrappers also means they can sidestep the impact of the new tax rules from the outset.
Summarising, Darren said: “Without a doubt, property investment still represents a great option despite these changes. More of us in the UK are living longer, we can’t create more space for housebuilding and the tightening of the mortgage market means many people still cannot afford to buy their home, all of which means the capital values of property are set to continue rising over the long term, and there is likely to be a strong market for rental property well into the future, akin to what has been the norm in Europe for many years now.”
Don’t be caught out
Darren advises to tread cautiously. “While the real pros have been gearing up for this change for some time, I believe there is a whole host of people who have just started to be affected and in 2019 we’ll witness a tsunami of landlords divesting property,” he said.
“If you are thinking of seizing the opportunity to buy into property for the first time, consider your goal carefully. For example, is it cashflow you’re after? If so, you need to be thinking about HMOs (houses of multiple occupancy) or serviced accommodation with a higher monthly turnover, where you can earn much more income per month than with a traditional buy-to-let.
“If it’s simply covering your costs with the potential for long term capital appreciation, then you’re looking for something else altogether – most likely a good quality domestic property in a sought-after residential location. You shouldn’t rule out commercial property either, which often offers significant monthly income potential without some of the emotional challenges that can accompany residential tenants.”
Darren will be sharing his own business success story at the next seminar of our InspiringBusiness2018 campaign on Thursday 22nd November. To book your place, click here.
If you are thinking about purchasing a residential or buy-to-let property, contact us for help with your conveyancing needs and general legal advice, including tenancy agreements, via firstname.lastname@example.org or (01482) 225566.