How to stop property tax changes reducing buy-to-let investment profits

Buy-to-let investment strategies you should be considering NOW

New investment research by – a government authorised protection scheme for landlords, letting agents and tenants – has found that almost half of buy-to-let investors are planning changes to the way they hold property as a response to UK property tax changes imposed over the last 18 months.

In this post, you’ll learn what you can do to minimise and perhaps eliminate the negative effects of the three major tax changes made by the UK government since the start of 2016.

What tax changes affect buy-to-let investment?

The government – in its infinite wisdom, of course – has made three major tax changes since the beginning of 2016:

  1. Firstly, they introduced a stamp duty surcharge on second homes. The extra 3% payable means that stamp duty on a £300,000 buy-to-let investment property has increased from £5,000 to £14,000, for example.
  2. Secondly, mortgage interest tax relief at the higher rate of income tax is being phased out. By 2020, higher rate taxpayers will only be able to claim mortgage interest tax relief at the basic rate. Effectively, higher rate taxpayers will be paying more income tax on their buy-to-let investment rental income. (Read our article UK property tax: how mortgage interest tax relief is changing for more information.)
  3. Thirdly, you can no longer claim 10% of rental income as a wear and tear expense. You will have to produce receipts to show what you have paid on wear and tear maintenance, and claim against these.

How are buy-to-let investors coping with these changes?

The mydeposit survey found that almost nine out of 10 property investors own between one and four properties. A fifth of these doesn’t believe the property tax changes will affect them.

However, 44% plan to make changes to the way they hold their property investments to reduce the effect of the tax changes. Many of these set up limited companies to invest in property, while a quarter has said they will just raise rents to make up any shortfall caused by an extra tax burden.

If you are a higher rate taxpayer or could be in the future, the time to review your buy-to-let investments for the effect of the property tax changes is now. You cannot afford to delay. Fortunately, there are ways to mitigate the extra tax that the government is trying to grab from property investors.

How can buy-to-let investors reduce their tax liability?

Strategies that you can use to reduce or perhaps eliminate the added tax burden are many and varied. They range from the simple to the more complex. Here are four of the easiest strategies to employ:

1.      Review your buy-to-let mortgage now

Interest rates have never been lower, but that could change as inflation picks up. In truth, you should review your mortgages at least every two years, if not annually.

Right now, lenders are hypercompetitive. By switching to a short or medium-term fixed rate, you could reduce the interest you pay. It will increase your bottom line and reduce the effect of the phasing out of mortgage interest tax relief for higher rate taxpayers.

The demand for five-year fixed rate deals has jumped in the last couple of months, clearly indicating that investors and homeowners believe that the next move in interest rates will be up.

2.      Transfer investment property to your lower-taxed spouse

If you pay tax at the higher rate and your spouse pays at the basic rate or does not pay tax, then this is perhaps the easiest and cheapest fix to make. Transfers between spouses are not treated as sales, so you won’t have to pay stamp duty or capital gains tax.

Sit down with an accountant and make sure that the added income doesn’t take your spouse for the higher income tax band before you do this.

3.      Raise your rents

It is something that I bet the government didn’t consider when it announced the tax changes, especially the way that mortgage interest tax relief is calculated. It’s probably the easiest of all strategies but does rely on being able to remain competitive in your property’s location. Review rents in the area, ensure you have a rent review clause in your tenancy agreement, and if your rent is on the low side, increase it.

4.      Invest in buy-to-let via a limited company

You could set up a limited company to hold your buy-to-let properties. It is more likely to be advantageous for larger portfolios, or for investors who intend to grow their portfolios.

Instead of paying tax at your marginal income tax rate, you will pay corporation tax on the profits made – this is due to be reduced to 17% in the coming years. You can also offset all your mortgage costs and other expenses as business expenses against your rental income when calculating profits.

Also, each person has a £5,000 tax allowance on dividends (though this is reducing to £2,000 from 2018/19). Dividends above this level are taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for additional rate taxpayers.

If you’re considering this strategy, you should take specialist tax advice to weigh up the benefits and costs. For example:

  • The transfer would count as a disposal and create a potential CGT liability.
  • The company would need to pay stamp duty on the ‘purchase’.
  • You will need to file annual returns and have an accountant draw up the annual accounts.
  • One final drawback of transferring into a limited company is the Annual Tax on Enveloped Dwellings (ATED), and from April 2016 this will be charged at a rate of £3,500 on homes worth more than £500,000 and rises to more than £200,000 on a home valued at £20 million.

What’s the best strategy for you?

Whether the above strategies will work best for you depends on your tax situation. You should always take advice before making any changes and consider your current and anticipated future tax positions. Contact one of the team today on +44 207 923 6100. We’ll help you review your current portfolio and explain potential property investment strategies that will maximise your returns and minimise tax.

Live with passion,

Brett Alegre-Wood

Brett Alegre-Wood
September 19, 2017

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