In light of continued introductions and changes to legislation affecting how much tax landlords have to pay on profits from rental income, many property industry commentators are predicting a slow death of the buy-to-let marketplace. While headlines from the UK Government’s plans may make the prospect of being a landlord – whether you’re already a landlord or considering investing in a buy-to-let property – unattractive, it is wrong to suggest there is no opportunity to make a healthy profit from property. No matter whether you are an accidental landlord looking to rent out one property, or a portfolio landlord making your living from your investments, it is still possible to reduce the tax you pay on rental income and increase your profits from your buy-to-let.
Upcoming Changes to Tax Deductible Finance Costs
From April 2017, there has been a phasing in of a “finance cost restriction” of what residential landlords can claim tax relief for. This means that for the tax year 2017-18, only 75% of all accrued finance costs will be deductible from rental income. This will then reduce by 25% in each subsequent year, so that in the tax year 2020-21 no finance costs will be tax deductible.
However, landlords will be able to claim a basic rate tax reduction in lieu of these changes. The tax reduction will work in reverse to the finance cost restriction, allowing landlords to claim 25% basic rate tax relief in the tax year 2017-18, increasing 25% per year until it reaches 100% for the tax year 2020-21.
The changes essentially mean that landlords will calculate their income and tax liability prior to the deduction of finance costs, and then claim the tax relief later. At present, landlords deduct finance costs from their rental income for the purposes of calculating what tax needs to be paid.
This change might mean:
- Private landlords end up paying more in tax
- Landlords currently in the lower rate tax bracket moving into the higher tax bracket due to rental income
- Landlords see a reduction in, or lose, any means tested benefits they currently receive, including child benefit and tax credits
Each landlord’s individual circumstances will dictate the extent to which they are affected, but even if the impact on themselves will be minimal, it remains essential to be fully aware of the changes and what they mean.
Click below to calculate the impact of section 24 on your rental income:
What are These Tax Deductible Finance Costs?
Currently, the finance costs that can be deducted from rental income, and will be subject to the restriction, are:
- Interest on mortgages, other loans used to buy property or furnishings for property, and overdrafts
- Alternative finance returns
- Fees and other costs associated with applying for and repaying mortgages and loans
- Any discounts, premiums, and disguised interest
Landlords who use a loan or combined mortgage across residential and commercial property, will be expected to apportion their interest fees to work out the costs for the residential property aspect. All existing fees associated with commercial property remain tax deductible.
If you are a landlord who has used part of a loan for property and another portion for a different reason, you will also need to calculate the appropriate interest that is applicable to the finance used for the residential property.
What Will These Changes Mean for the Rental Market?
As is often the case whenever something comes along to threaten the bottom line of landlords, the first thing to come to mind is “rents will go up.” In reality, these changes are unlikely to lead to rent increases above the expected levels over the next 4-5 years, particularly in regions where the market will not be able to sustain a rise in payments. While on the face of it landlords may have to swallow this one, that doesn’t mean there aren’t still huge opportunities for private landlords to both reduce their tax and save money elsewhere.
What are a Landlord’s Options Now?
To reduce the tax you will pay on your rental income from April 2017, there are several options you may wish to consider. Remember that the viability of these is dependent on your own circumstances. We encourage you to seek advice from your accountant or another tax consultant before committing to any of these.
Set up a Limited Company to Buy and Own Property
Companies are still able to claim full tax relief on finance costs from April 2017. Landlords have the option of transferring a property they own to company ownership, but:
- Capital gains tax will be payable on the difference between the current value and the price of the property when the mortgage was taken out
- Stamp duty will be payable by the company as it is effectively buying the property from you, the private individual
- Your mortgage may need to be changed due to the property being held by a company and not a private individual. Company mortgages can be difficult to find and interest rates from these are often higher. Are you saving money elsewhere just to spend it somewhere else? Work out the balance and consider what's best for you.
- It is clear this option has the potential to save you money but also to cost a considerable sum in the short term.
This option is explored in further detail in our article, Read This Before You Rush to Form a Limited Company.
Transfer Rental Income to the Other Property Owner
Landlords who own a property with their spouse, business partner, friend, or anyone else, may be able to transfer a higher proportion of the rent to their co-owner. This works if the landlord will move into a higher tax rate bracket but their co-owner can take more of the rent and remain a lower rate taxpayer.
Married couples will need to submit Form 17 to HMRC to avoid paying excess tax.
While on the face of it this option seems a no-brainer, how you structure your rental payments between yourself and your co-owner(s) now can impact elsewhere later, including on capital gains tax charges and inheritance tax.
Switch to Holiday Lets
Admittedly a “left field” option, this will only be viable if you own a property in an area where short-term or holiday accommodation has a high demand. Holiday lets are exempt from the upcoming tax changes, enabling you to claim full relief from finance charges.
We have covered this possibility in great detail, including the pros and cons, in our post Should You Switch to Holiday Lets?
Other Tax Deductible Expenses and Opportunities to Save Money and Increase Your Profits
Through the years, numerous sources have estimated there are millions of private landlords in the UK that are paying more tax than they need to, due to not being aware of, or not claiming, all of their allowable deductions. If the upcoming changes to how finance costs will be treated for tax purposes have made you sit up and take notice, why not use this opportunity to explore your whole buy-to-let operation from a business perspective and ensure you are increasing profits across the board?
Is Spending to Save Tax Costing You Money?
A quick note on what actually constitutes a saving before we look at what you should be claiming. It is very easy to fall into the trap, whether you’re an experienced landlord or not, of spending money on something because it allows you to make a deduction against your tax bill. Ultimately, this approach is costing you money and reducing your profits. If you are spending on non-essentials just to save tax, then you’re just spending; saving doesn’t come into it. Clearly if you spend on a non-essential that subsequently allows you to increase the rent and therefore your profits in the long-term, this represents an opportunity you may wish to explore.
What are the allowable tax deductible expenses that aren’t subject to upcoming changes? Are you claiming them, and do you have an opportunity to make a saving?
Letting Agent Fees
Any costs you incur in the process of finding tenants are tax deductible. This includes all advertising fees as well as any associated costs related to the inventory make, credit checking, writing of the tenancy agreement, and protecting the tenant’s deposit. If you are a portfolio landlord that still uses a high street letting agent, this could represent a significant saving. On top of this, you can also deduct your monthly letting agent fees if you’re not already taking these off your rental income. Let’s say you rent a property out at £1,000 per month and your letting agent takes a 15% management fee, that’s £1,800 you can claim on just one property.
With tenant fees set to be banned across the UK from 1st June 2019 - they already are in Scotland, and will be in Wales prior to this date - landlords are likely to find themselves paying more to letting agents and will probably be increasing the rent on their property, too.
Private landlords concerned about the letting agent fees they are currently paying can increase their profits by choosing a cheaper way to find tenants and manage their properties. Online letting agents provide this opportunity.
If you’re not already registered with Upad, register here and discover how our landlords save over £750 on average per tenancy against the cost of a traditional letting agent.
Whatever type of landlord insurance you opt for, this is fully tax deductible. Remember that the terms of your mortgage will often dictate a specific type of insurance is needed, or particular features are included in your policy- such as rent guarantee cover. Be sure you have the correct landlord insurance cover both for your circumstances and to satisfy your mortgage provider.
If you opt to transfer your property to a limited company or manage your property as a holiday let, remember to check how this will impact your landlord insurance policy.
Maintenance, Repairs, and Furniture
Whatever you spend on maintenance and repairs for your property is tax deductible. Remember that if your landlord insurance reimburses you for any costs incurred here you will need to include these as income on your tax return.
Until the 2016-17 tax year, landlords could claim 10% of their net rental income as a “wear and tear allowance.” Now, claims can only be made if an item of furniture or an appliance has been replaced. However, landlords can claim back the full cost and any associated costs, including delivery or mileage driven to collect an item.
Legal and Accounting Fees
It is easy for legal and accounting fees to add up when you’re a private landlord. Depending on how you operate and the way your tax affairs are structured, this could represent a significant expense.
As most landlords aren’t legal or accounting experts themselves, these expenses are pretty much essential. While you may have been using the same solicitor or accountant for many years, make sure you’re getting full value for the price you’re paying.
Ground Rents, Service Charges, and Utility Bills
Where you own the leasehold on a property, you can claim back ground rent costs and any service charges you pay. Make sure you’re claiming back these charges if they’re applicable; if you rent out flats you own the leasehold on and are paying such costs you could save a considerable sum of money if you’re not already claiming back these expenses.
If council tax and utility bills are included in the rent payment or paid for by yourself, these are tax deductible too. Where your tenants are responsible for these bills, you can still claim what you pay during void periods when you will become liable for keeping accounts up to date.
Capital Gains Tax Allowance
While this is only applicable if you’re planning on selling a property, as of the 2017-18 tax year you have a personal capital gains tax allowance of £11,100. Make use of your partner’s allowance too and double the amount you don’t need to pay any tax on. Given the capital gains tax rate on second homes remains at 18% - 28% having fallen to 10% - 20% for other cases, using your partner’s allowance enables you to make a significant saving.
Beware the Love Tax
If you move in with your partner and keep your existing property to let out, you may be subject to the Stamp Duty Land Tax, also dubbed the “Love Tax.”
You can read about what the love tax means and how you may be able to avoid it – and an early hit to your rental profits – here.
Upad’s Mortgage Relief Calculator
Use our mortgage relief calculator to understand what the introduction of the finance cost restriction in April 2017 means for your buy-to-let profits.
New landlords are also encouraged to read the UK Government’s case studies looking at taxation from rental income.
Are you ready for these changes? What opportunities have you now identified that will help you save money and enjoy higher profits from your property or portfolio?
Join the Upad Landlord Club to access our tax helpline and receive independent advice and assistance in deciding the most tax efficient solution for your buy-to-let business.