Buy to let landlords of UK residential properties have been bombarded with tax changes in the last year.

In the past, letting residential property (even by individuals) was treated as a ‘property business’ for the purposes of calculating the taxable profit. Therefore, on normal business tax rules, interest paid on a loan used to purchase a property which is let, was deducted from the rental income received in the property business. For individuals who are landlords, the Government has changed this longstanding rule. In future, instead of deducting the interest from the letting profit, before that profit is taxed, the individual will only be allowed an income tax deduction at the basic rate (20%) on the interest paid.

What is changing?

This is a major change for landlords which will be phased in from 2017/18, with transitional rules until 2020/21. During the transitional years, the amount of the tax deduction from rents will reduce and the proportion of loan interest that will only qualify for basic rate tax relief will increase. In the transitional years, landlords will be able to claim:
• 2017/18 – 75% of the interest against rents, 25% basic rate tax relief
• 2018/19 – 50% of the interest against rents, 50% basic rate tax relief
• 2019/20 – 25% of the interest against rents, 75% basic rate tax relief.
• from 2020/21, all financing costs incurred by a landlord will be given as a basic rate tax reduction.

However, as now, any unrelieved interest can be carried forward to future years. HMRC has confirmed that the change will have no effect where a property meets all the criteria to be a furnished holiday letting.

The consequences

With interest rates expected to rise over the next few years, landlords will need to consider these issues carefully when setting rent levels in future.
The change could significantly affect higher and additional rate taxpayers who let out highly geared residential properties. Individuals who currently pay tax at 40% or 45% on letting profits will pay more tax as a result of this change, although the increases planned for personal allowances and the basic rate band up to 2020 will mitigate the impact a little. However, as relief will be given after an individual’s personal allowance has been calculated, many individuals who let properties will find that their personal allowance is restricted in future.
Conversely, where the personal allowance is not fully used in 2016/17 but is fully used in 2017/18 and later years, some unrelieved loan interest may be carried forward in those years.

Ownership through a company

This change will have no direct impact on those who own and let residential properties through a company: companies will continue to deduct loan interest as a business expense and get effective relief at up to 20% (although this will fall in future as the rate of corporation tax falls). The ability to take income flexibly in the form of dividends will be more attractive to landlords who might otherwise lose their personal allowance. Of course, the effective rate of tax on dividend income changed from 6 April 2016. Those taking low levels of dividends may suffer a lower effective rate because of the new £5,000 allowance, but those taking higher dividends may pay more as the rate of tax on dividends rises.
As there are many other issues to consider, deciding on the most efficient way to hold buy-to-let properties is not straight forward – the best option will depend on individual circumstances and long term objectives. Incorporation of an existing property letting business may not be practicable in many cases, including where this would result in a large stamp duty land tax liability.

Wear and tear allowance

Wear and tear allowance is abolished for 2016/17 onwards for income tax purposes. This will remove the established system of allowing a fixed annual deduction for wear and tear on soft furnishings and moveable furniture used in a furnished letting business (10% of the rents less costs normally paid by the tenant) from April 2016. For 2016/17 onwards, landlords may only claim expenses actually incurred during the tax year, excluding any element of replacement expenditure that represents an improvement.
For furnished lettings, this change may benefit landlords letting high value properties where their annual costs for replacement of soft furnishings and moveable furniture are high. Conversely, landlords at the lower end of the market will need to carefully consider the impact that this will have on their rental profit in future years.
The change could also benefit landlords of partly furnished properties, as the new relief applies to all landlords of residential dwelling houses, no matter what the level of furnishing.

Rent a room relief
The annual amount that landlords can receive from letting a room in their own home before tax becomes payable increased from £4,250 to £7,500 (£144 per week) from April 2016 onwards. There are no proposals to change the other rules for the relief, so the new £7,500 limit is available as an exemption or, where rents are higher, as a fixed deduction from rents.

Next steps
For a more detailed discussion of how the new rules can affect you and what you might be able to do to improve your tax position, please contact Mel Hackney or Steve Wiltshire on 0117 304 8455.