The 2015 Budget included a massive blow to buy-to-let landlords in the form of huge cuts to their tax relief. Currently, landlords benefit from 40 and 45% tax relief on their mortgage interest payments. Osborne intends to reduce this to 20% by April 2020 in order to, in his own words, “level the playing field” with home owners who live in their properties. The Chancellor feels it is “unfair” that only landlords have access to this particular tax break.
The changes will effect UK non resident landlords in the same way.
This will obviously have a detrimental impact on landlords’ finances, but the accountants PwC have come up with a potential solution to keep losses to a minimum. Their evaluation demonstrates that, if you are a private landlord, turning yourself into a company could end up saving you a substantial sum in your tax bill. By ‘incorporating a business’ you become subject to a different set of tax regulations which tax profit.
Paul Emery, of PwC, explains;
“This is because a company is paying tax on the actual profit and therefore the rate does not fluctuate wildly. If the profit reduces, so does the tax. If the rental property is run privately, there is a scenario where, because you no longer get full tax relief on your expenses, you can pay tax even if there is no profit. That means potentially enormous effective rates of tax.”
PwC’s report looks forward to 2020, when we can expect that rates of interest will be higher. As an example, consider a £100,000 property, bought with an 85% loan-to-value mortgage, with a 5% mortgage interest rate, owned by a landlord in a high tax bracket. As a private landlord, the tax on this would be 106% and result in a loss of £100 over the year. As an incorporated business, there would be a tax rate of only 49.2%, securing £888 that year.
If we think about mortgage rates climbing higher, the difference between private landlords and business property ownership widens greatly. For example, if rates rise to 6% a property business would pay 49.2% and a private landlord would be stung for 186.7%, creating a loss of £780.
Obviously tax is not the only variable when you are deciding whether or not to become an incorporated business. Mr Emery confirms, “Although incorporating your business helps you guarantee your monthly tax bill, it is not a magic solution. Tax is only one consideration when forming a company. For example, audited accounts might need to be filed…Other taxes such as stamp duty and capital gains tax could affect profits from a rental business, especially for a landlord with only a handful of properties.”
Being a sole trader or part of a business partnership also has tax implications. A business partnership would be entitled to stamp duty tax relief, whereas a sole trader would pay stamp duty again, determined by property prices, when incorporating the business. Another possible variation is for either partnerships or sole traders who own more than 6 properties. This would then be categorised as a ‘commercial property business’ for tax purposes and pay 4% flat rate of stamp duty when selling.
As Mr Emery highlights, “The big tax difference is capital gains tax when the company finally comes to sell and dividend the profit to the owner at 49% compared to 28% for a private landlord – but at least you would know what your effective ‘rate of tax’ is, and if you are reliant on the income rather than the appreciation of price, it may be a hit worth taking.”
Swings and roundabouts perhaps – but it is essential to work out the best option for your individual circumstances before the impact of Osborne’s new rates takes effect.
