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By Kevin McDaid, Jun 28 2016 01:17PM

Two major changes to the taxation of residential property will put a squeeze on both the purchase of property and rental profits landlords receive.


On 01/04/16 the Stamp Duty Land TAX (SDLT) 3% hike came in to play in England & Wales (or Land & Buildings Transactions Tax [LBTT] in Scotland) for the purchase of additional residential property valued at £40,000 or higher.


Comparing the impact of the new rules with the old ones, a purchase of a £250,000 2nd residence from April 2016 would incur SDLT of £12,500 compared to £5,000 if purchased in March 2016; an increase of 150%.


So purchasing additional properties has become more expensive. No surprise then that, according to the Council of Mortgage lenders, the purchase of BTL mortgages was up by 226% in March 2016 compared to the same month in 2015, as landlords rushed to beat the hike.


The second major change to the taxation of residential property landlords does not commence until April 2017. (However, when you read on, you will see that all landlords should be considering their options now.) This is the restriction to 20% in income tax relief for loan interest, being phased in as follows:



Case studies 4 & 5 at http://www.propertytaxadvisers.co.uk/case-studies/4591698202 provide in depth commentary on the effects of the restriction but in very simple terms an individual who is a 40% taxpayer and had interest of £5,000 on a mortgage would receive £2,000 of tax relief pre April 2017. By the time we get to April 2020 the same £5,000 mortgage interest will only receive £1,000 tax relief. This would result in an additional £400 in tax becoming due.

You can imagine for a landlord with a larger property portfolio, say with £100,000 in interest payments instead of £5,000, this restriction could be devastating.


The case studies clearly show that it is not just landlords who are currently paying tax at 40% who will be impacted upon by these changes. The way the restriction is to be applied from April 2017 will mean that some landlords who are currently 20% taxpayers will become 40% taxpayers even though their income may not increase. The change could also impact on the repayment of student loans and entitlement to child benefit and tax credits.


All in all, not great for residential landlords. Consequently, BTL investors should seriously be considering their future choices now.


If they decide to sell up and there is an increase in the price that they receive for the BTL over the price paid for it, any such gain will be subject to Capital Gains Tax (CGT). For the current 2016/17 tax year there is an annual CGT exemption of £11,100 but if the gain exceeds this amount it will be taxable at either 18% (on any part of the gain falling within the individual’s 20% income tax bracket) or at 28%.


If you have a spouse/civil partner who has not used up their annual CGT exemption consider taking advantage of this by transferring part of the property into their name but be aware of the SDLT implications outlined in the blog dated 25/04/16.


I have highlighted annual CGT exemption because one of the options open to residential landlords is to reduce the size of the property portfolio over a period of years to take advantage of multiple annual exemptions.


Imagine a scenario with Simon, a landlord who earns £38,000 P/A from his full time employment. He has a row of 5 terraced rental properties each earning him £5,000 less £3,000 interest and £1,000 in other expenses. This leaves him with net rental profits of £1,000 P/A per property under the current interest regime. He falls just inside the 20% tax bracket for 2016/17 and so pays £1,000 tax on his total net rental profits.


He anticipates getting promoted at work inside the next 2 years (this will immediately increase his salary to £44,000). This, coupled with the loan interest changes, leaves Simon pretty certain that he will be a 40% taxpayer on the full amount of his rental profits by the time the interest rate changes are fully implemented by 2020. This would mean that pre interest rental income per property would be £4,000 taxable at 40% = £1,600 less interest of £3,000 x 20% = £600, i.e. he would pay £1,000 in tax per property on the £1,000 profits he makes! Unsurprisingly, Simon decides he must concentrate on his career and sell up his rental properties.

Each of them is standing at a £10,000 gain in 2016/17(£50,000 in total). If he was to sell all the properties in one go his gain (after the annual exemption of £11,100 and allowing for legal costs of £5,900 in total) would be £34,000. The majority of this would be taxable at the higher rate of 28% (say £30,000) with the balance of £4,000 being taxable at 18%. The total tax liability would be £9,120 leaving Simon with just under £35,000 from the sales (taking the legal costs into account).


If Simon was to spread the sale of the properties over 4 years, all but a fraction of the gains would be covered by his annual CGT exemptions leaving a negligible amount of tax payable. Even just spreading the sale over 2 years to gain the benefit of a 2nd annual exemption and an extra £4,000 taxable at the lower 18% tax rate would reduce the overall tax liability down to £5,300, a saving of £3,800.


NB in the March 2016 Budget, the Chancellor announced a reduction in the CGT rates mentioned above to apply from April 2016. The top rate is now 20% (from 28%) and the standard rate is 10% (from 18%). Good news! Unfortunately, these rates do not apply to gains on sales of residential property where the old rates will continue to apply. Landlords, can surely now see that the Chancellor sees you as his golden goose as far as tax revenue is concerned.


It should be noted that, subject to HMRC/Treasury denying this to be the case, it appears that sales of shares in a property investment company will also qualify for these lower CGT rates so if you can sell the shares rather than the underlying property you can save CGT at the rate of 8%.


This moves us nicely on to, potentially, using a company for your property investments if you decide not to sell up. The main reason you would be likely to do this is because the loan interest restriction does not apply to companies. Also, bear in mind that from April 2020 companies are only due to pay tax at the rate of 17% and, thus, via incorporation, it seems that all landlords tax worries just melt away. If only!


Let us go back to Simon, our promotion seeking basic rate taxpaying landlord with the 5 properties currently generating £5,000 net rental profits. If he decided to incorporate in 2016/17 he would be faced with a CGT bill of £9,120 for selling the properties to his newly formed company. CGT arising in 2016/17 becomes due for payment by 31 January 2018.


We then have to consider SDLT. Let us assume that each property is valued at £150,000. Transferring these properties to a limited company would create an SDLT liability of £37,500. SDLT becomes due and payable within 30 days of the transaction.


Even assuming the legal fees would be considerably down on the £5,900 he would incur if selling them outright, let us assume he would owe at least £2,000 - Simon would have to fork out £39,500 immediately with a further £9,120 CGT payable by 31/01/2018. In total, he would be £48,620 worse off if he transfers his properties to a limited company to take advantage of the loan interest restrictions not applying to companies.


Yes, there are certain reliefs that could exempt Simon from both CGT and SDLT and if he could obtain these reliefs, incorporation could well be beneficial. For CGT relief, Simon’s rental income would need to be accepted as being a business rather than the default position of being an investment. With Simon being in full time employment, it would seem unlikely that he would be putting sufficient time and effort into looking after the 5 properties to be regarded as operating a business. For SDLT, relief applies on incorporation of a partnership. Clearly, this is not the case.


Consequently, Simon needs to make savings in the long term of almost £49,000 in order to make the short term pain of incorporation worthwhile.


Let us fast forward to 2020 when the loan interest restrictions are in full effect. Via the company Simon’s rental profits are £5,000 at 17% = £850, net income of £4,150 compared to nothing if he continues as an individual landlord. Under the new dividend rules applying from April 2016, Simon could pay these post tax profits to himself tax free. This would mean that it would take him 12 years to recoup the costs he incurred via incorporation.


N.B. it is assumed that the rental income and expenditure remain the same under the company as it would operating as an individual although, in reality, it is likely that mortgage interest rates within a company would be slightly higher and, certainly, administration costs would be higher.


If Simon decides not to incorporate due to the high initial costs, he knows that he will have no rental profits after tax but he may be prepared to live with this because the property values are steadily increasing.


In 15 years he intends to retire and sell a property each tax year to take advantage of his annual CGT exemption. Each property will sell for £200,000. The mortgages are paid up so he will have net proceeds of £1m before tax and legal costs. Each property cost £140,000 and so is standing at a gain of £60,000. After the annual exemption is deducted he would be liable to pay CGT on gains of say £45,000 per property, at 18% on the first £20,000 and 28% on £25,000. The CGT payable would be £10,600 leaving him with £49,400 profit per property (pre legal costs). Over a 5 year period he would receive £947,000 net.


If he went down the company route his taxable gains would only be £50,000 per property because, of course, he had gains of £10,000 on each when incorporating in 2016/17. There is no annual exemption in the company but the tax is only payable at the rate of 17%. The CGT would be £8,500 per property (£42,500 total), a saving of £2,100 per property if selling as in individual.


Of course, it is the company that has sold the property not Simon. Consequently, he has to extract the post gains profit out of the company to enjoy it. Extracting profits means more tax!


If he decides to liquidate the company this will create a personal capital gains tax liability for Simon as follows:


£207,500 is available to distribute. Annual CGT exemption = £15,000 leaving £192,500, taxable (£20,000 x 20% = £3,600 and £172,500 x 28% = £48,300). Total personal tax due = £51,900. Net proceeds £905,600.


This compares to £947,000 via Simon selling as an individual (admittedly, over a 5 year period to take advantage of his annual CGT exemptions and 20% tax band). However, a saving of over £41,000 clearly makes this an option that cannot be disregarded.


Conclusion – the change in the rules for loan interest deductions makes operating via a company an attractive proposition for any landlord likely to be liable to 40% tax on rental profits. However, unless you are currently operating as a partnership you will be hit with an immediate SDLT charge. Unless you are deemed to be operating a business you will, potentially, also have a CGT liability to pay.


The income tax savings you may make via operating as a company have to be compared to the upfront tax charges of becoming a company in the first instance. Of course, there will be additional costs of the incorporation such as legal and accountancy fees and, in the longer term, the administrative costs of operating as a company will be certainly be higher than operating as an individual/partnership.


Even if the company route is chosen you have project forward to the date when you, ultimately, anticipate disposing of the properties. Getting the money out of the company could create a CGT liability far in excess of any income tax savings made.


Knowing the full facts enables you to make the right decisions.


See http://www.propertytaxadvisers.co.uk/pricing/4592100439 -‘A huge tax bombshell’ as to how we can steer you through the murky waters.


By Kevin McDaid, Apr 25 2016 12:37PM

Gary & Tina, a married couple from Bradford, purchase a BTL in 2016 for £130,000.

Gary is a higher rate taxpayer via his employment whilst Tina pays no tax in respect of her part time employment. They have 3 young children.


The BTL produces an annual rental profit of £3,000 per annum.

If the property was jointly owned the default position would be that the rental profits would be split 50/50 creating a £600 income tax liability for Gary, whilst Tina would pay no tax. As they have 3 children, child benefit will be jeopardised if Gary’s total taxable income exceeds £50,000.


It certainly makes sense to consider transferring the beneficial ownership of the BTL solely or partly into Tina’s name. Let us assume that Tina can receive the full £3,000 rental income without being liable to pay any tax. This will save the couple £600 in tax each year until they come to dispose of the property in 2020 (total saving after 4 years £2,400).


In 2020 the property will sell for £155,000. It was purchased for £130,000.

The gain would be as follows:


The obvious suggestion would be transfer the property back into joint ownership prior to the sale in order to benefit from a second annual CGT exemption of £12,500. This would result in there being nil CGT payable. Remember CGT is NOT payable on interspouse transfers.


However, if the property had a £80,000 mortgage on it, the transfer from Tina to 50/50 joint ownership would create a transfer of consideration of 50% of £80,000, i.e. £40,000 liable to SDLT at 3% = £1,200.


Until 01/04/16 SDLT would not have been an issue had the consideration been below £125,000. Now, with legal costs of transferring the property in addition to the SDLT, the tax savings to be made from the transfer become relatively small. Indeed, was it even worth transferring the property into Tina’s sole name in the first instance?


A potential solution would be to transfer over just under £40,000 of the mortgage from Tina to Gary in order to avoid the SDLT charge.

This would mean that Gary would not quite own 50% of the property and so the gain may be split, say 51/49 in favour of Tina. As a result Tina would be liable to CGT on £250 at 18% = £45. Gary would not pay any CGT.


As a couple, they pay no income tax on the rental income, no SDLT on the transfer back into joint ownership, and save over £2,200 in CGT by following this course of action.


Conclusion

What had been standard practice up until 04/2016 (automatically transferring property from the individual lower tax paying spouse back into joint ownership in order to benefit from a second annual CGT exemption) is no longer, necessarily, the ‘no brainer’ that it once was.


More number crunching required I am afraid.


Kevin McDaid, For & on behalf of Tax Facts Ltd

04/04/2016



By Kevin McDaid, Apr 25 2016 12:34PM

Currently (and until April 2021) everybody is entitled to an Inheritance Tax (IHT) allowance of £325,000 or £650,000 per couple (married/civil partners). This is called the nil rate band (NRB). Below these amounts IHT at the rate of 40% is not payable.


It was announced in the summer budget 2015 that a new IHT threshold would be introduced – the new residence nil rate band (RNRB). Although this will not come into operation until April 2017 and will not be fully implemented until April 2020, it will allow the family home to be passed on death to a ‘lineal descendant’ (e.g. child, grandchild) without any IHT being payable even though the estate may exceed the NRB of £325,000 for an individual or £650,000 for a couple.


The available nil rate bands will be as follows for the forthcoming years:



The Government has stated that from April 2021 the standard IHT nil rate band and the RNRB will increase in line with the Consumer Prices Index, rounded up to the nearest £1,000.


There are a number of points to consider in order to claim the full allowance:


Qualifying residential interest


• The RNRB is available only to those who held a ‘qualifying residential interest’ immediately before their death. Put simply, you need to own or have part ownership of a property that was their home at some point after 8 July 2015.


• This means that it is possible to ‘downsize’ the family home or go into care (so no home at all is held at death) and still qualify for the RNRB.


• However, the additional band does not mean a total estate of £1 million can be passed on as it only applies to the family home. This is possibly best demonstrated by way of an example:


Cliff dies in May 2017 leaving a wife, Joan, and their adult children, Arthur & Joanne. The family home was valued at £500,000 at that time and other assets, such as investments and cash, totalled £1,000,000 (total estate £1.5m). Everything was held jointly between Cliff and Joan.


Assuming Cliff leaves everything to Joan:


• The spousal exemption applies meaning that ownership of the family home and other assets passes to Joan without any IHT being due and Cliff’s standard NRB and RNRB are unused.


• Subsequently, in September 2019, Joan goes into a care home and the family home is sold for £570,000. Joan passes away in July 2020 and leaves her estate equally to her children Arthur & Joanne. At that time the estate was worth of £1,525,000.


• Joan’s executors have her unused standard NRB of £325,000 and, even though she no longer owned a home at death, she still qualifies for the RNRB because of the home ownership after 8 July 2015. As Cliff left everything to Joan, her executors can claim his unused RNRB in addition to his unused standard NRB.


• Joan’s estate can therefore benefit from a total of £1m in nil rate bands; two standard NRBs of £325,000 and two RNRBs of £175,000.


• If the value of the home had dropped below £350,000 at the time of Joan’s death, the total amount of RNRB available to Joan would have been limited to the value of the house.


• After allowing for the available nil rate bands, the residual value of the estate of £525,000 and inheritance tax of 40% means a tax liability of £210,000 on the amount being inherited by Arthur & Joanne.


Descendants


• Includes adopted children, step-children & fostered children or a spouse, surviving spouse or surviving civil partner of a lineal descendant who has not remarried by the time of the property owner’s death.


• If an individual, a married couple or civil partners do not have any children or grandchildren that qualify they will be unable to use the RNRB.


Transferring unused allowance


• The transferable RNRB must be claimed by the legal personal representatives within two years from the end of the month in which the second death occurs.


• Where the first death occurs before April 2017, an unused RNRB of £100,000 will be deemed to be available for carry forward when the surviving spouse or civil partner subsequently dies. This is the case regardless of whether or not the first to die owned a qualifying residential interest.


Large estates


• There is a ‘taper threshold’ for large estates which from April 2017 will be set at £2m.


• Where an individual leaves an estate in excess of £2m, the RNRB that can apply to their estate is reduced by £1 for every £2 the estate is over this threshold.


• In determining whether the £2m threshold is breached it is necessary to ignore reliefs and exemptions. This is an important provision as it means, for example, that one ignores business property relief (BPR) and agricultural property relief (APR), even though they are taken into account to calculate the liability to IHT.


• Consequently, in the above example of Cliff & Joan, if, in addition to the estate already described, Cliff & Joan had £2m worth of AIM listed shares qualifying for BPR, this would disqualify their right to the RNRB and push the tax on their estate up by £140,000 even though no IHT would be due on the shares.


As you can see, not everyone will benefit from the RNRB.






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What our clients said about us:

I have a portfolio of over 50 residential properties throughout the North of England.

I first came across Kevin in 2010 when he was performing capital allowances valuations in respect of houses of multiple occupation (HMO). At that point, not many accountants that I spoke to, had much of a clue about the ability to claim the allowances whilst many of those organisations who were in the know, were keen to do the valuations for a hefty fee but then really did not instil me with any confidence about the tax implications.

Kevin was different; we had an initial chat over the phone, there was no big sell and no hefty fee. Because he has a tax and surveying background, not only was he able to undertake the valuations he was able to liaise with my accountant to fully explain the tax implications and talk him through the reporting procedure.

There is no question that the tax savings I made hugely outweighed his fees.

Fast forward 5 years and there is no surprise that, once again, he seems to have a far greater understanding of the latest tax changes than the accountants of other landlords that I regularly speak with.

He has kept me fully updated on the tax implications of the loss of wear and tear and the changes in the allowability of loan interest. He has provided me with an in depth report showing how much post tax income I would have from the present day right through until 20/21 when the restriction is fully in force. It did not paint a pretty picture. In fact, I would go so far as to say, that I would almost certainly no longer be able to continue to operate as a property investor by 20/21 in a sole trader capacity. Consequently, as of 01/04/16, I am now operating as a limited company, Kevin guiding me and my accountant through the tricky incorporation maze and explaining the best profit extraction method going forward.

I would point out that we had been discussing the SDLT implications of incorporation on the run up to the Budget on 16/03/16. With over 50 properties this was going to be a hefty charge for me. We had anticipated there would be a relief for the transfer of more than 15 properties into company ownership. When it was announced in the Budget that this would not apply, Kevin contacted me on Budget day whilst I was in South America to break the news and to push for the transfer to take place by 31/03/16 in order to save an extra 3% SDLT, which I duly did.

Once again, big tax savings for reasonable costs but, most importantly to me, I know exactly where my business is going, how much money I can personally extract from the company & how much should be left in to help pay off existing mortgages or to expand the business.

It really is a no brainer to work with Kevin whether you are a large or small property investor.

 

JC, Leeds

 

We first used the tax services of Kevin almost 10 years ago when he was working for a local firm of chartered accountants. Having received an excellent service from him for a number of years (including expanding from a partnership to a limited company) we were delighted to hear that Kevin had set up on his own and had no hesitation in signing up as a client in 2012. He continues to offer a very personable and cost effective service. We would absolutely recommend him to any other small company like ours.  

In addition to our company, we have a small residential property portfolio and were contemplating disposing of one of the properties in 2014/15. Had we not consulted with Kevin prior to the sale, we would have been facing an unwelcome Capital Gains Tax Liability. However, by transferring the property from sole into joint ownership we were able to benefit from a second CGT exemption which saved us almost £2,000’.  

 

Mrs S (Company Director, Bingley)

I first met with Kevin in July 2015 because I was worried that I had been receiving rental income for 3 years but had not declared anything to the tax man. The reason I had not done so was because I had spent quite a bit doing it up when I first purchased it and, by my calculations, I had only just started to make a profit in the tax year ended 05/04/2015.

Kevin explained that not all the expenses would be allowable because some counted as improvements. He provided a fact sheet on ‘Revenue versus  Capital’ indicating that those costs that counted as improvements would, ultimately, be available to set against any gains on disposal of the BTL. He also clarified the other expenses I was entitled to claim.

He calculated the net profit from letting. Even though no tax was payable he advised that the income still needed to be reported to HMRC which he duly did via a letter as, he said, the amounts involved were below the level for which a tax return was required. Apparently, this saved me penalties for failing to submit tax returns by the due date.

A tax return will be required for 2015/16 and I will be using Kevin to prepare this as, last year, he took away my concerns in sorting out my tax in a professional manner. He is not expensive and I feel comfortable dealing with him.

I would be happy to recommend him based on my experience.

 

RT, Bradford.

BLOG INDEX - PLEASE SCROLL DOWN TO VIEW INDIVIDUAL ENTRIES.

How SDLT could change how rented property is owned by couples/civil partners.

CGT Reliefs on homes to be significantly restricted from 04/2020

Mortgage Interest Relief Restrictions - Are you ready?

Making Tax Digital (MTD) & the cash basis for landlords

Landlords lose legal challenge over BTL tax changes

When the sale of a property will be liable to Income Tax rather than CGT

CGT on BTL to be taxed as income - Don't worry, it is not going to happen

The Statutory Residence Test - Working full-time abroad

Replacement Furniture Relief.

How flexible are your pensions savings?

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