As previously reported, many buy-to-let property owners will see an increase in their tax on rental income as tax changes take effect between 6 April 2016 and 5 April 2020. The removal of the wear allowance is the first change, with effect from the 2016/17 tax year, followed by a gradual withdrawal of higher rate loan interest relief.
The detail of the changes is covered in our technical briefing.
What are the options for existing landlords who are affected?
Transferring the property to a family member
The loss of higher rate tax relief is only a problem for those who pay tax at 40 per cent or more. So it may be appropriate to consider whether the ownership of the property should now be transferred, typically to someone else in the family, not only for reasons of interest relief but also succession planning.
While a transfer to a spouse or civil partner who may pay tax at a lower rate would not result in any capital gains tax (CGT) being triggered, a transfer to another member of the family (say, children) could result in a capital gain if the current market value is greater than the base cost (broadly, the price paid plus improvements to the property). Reliefs for costs and any prior occupation as a main residence may further reduce this, so it is worth looking at this option before reviewing anything more complex.
In all cases, on a transfer to a spouse, civil partner or other family members, a stamp duty land tax (SDLT) charge could arise if there are borrowings (typically secured on the property) which are assumed by the transferee. In many cases though, this may not be the case and there may be no SDLT charged.
Transfer the property to a trust or company
Transfer of property to a trust for the benefit of adult children or grandchildren could be beneficial, especially where the net rental profit is to be fully paid out each year. However, there are a number of existing tax issues (potential inheritance tax and CGT charges), as well as new issues created by the loan interest restrictions, this option is likely to be less attractive except in very particular circumstances.
Companies are not restricted on the interest relief available, although, as they only currently pay tax at 20 per cent, relief is already only given at the same rate that will apply to individuals by 2020. So the option of transferring rental property to a company may be a better alternative than transfers directly to other family members or a trust because of the lower tax rate.
Where the rental income is not required for immediate personal needs, having this accumulate in a company at the lower corporate rate of tax would leave a greater profit to either pay down existing borrowing or to purchase additional property or other investments. In some situations, the use of a company can still provide a lower overall tax rate even if profits are extracted.
Again, on the transfer of a property to a company, both CGT and SDLT charges could arise, but there are reliefs available which may mitigate these charges.
For those who operate a property business, it may be possible to obtain incorporation relief which would allow the transfer of property to a company without any CGT charge. In that situation, the base cost of the property would transfer to the base cost of the shares and the property would be rebased in the company to current market value.
The key question is: do you have a property business? This will depend on a number of factors, such as the number of properties, the time dedicated to running the portfolio of properties, how this is managed, etc. Each case will depend on the facts.
An SDLT charge would still arise on incorporation although, for those who operate their unincorporated property business in partnership (and that may include a partnership with their spouse or civil partner), the SDLT could also be exempted. Whether a partnership business exists, compared to joint ownership, will also depend on specific facts.
Borrowings in a company
Some may be concerned that borrowings in a company will give them unfavourable interest rates on their mortgage. Additionally, many banks will ask for a personal guarantee.
However, if a company is being considered, then the use of an unlimited company (as opposed to the usual limited company) may provide the bank with comfort over the liability, so as to give the same rates as personal borrowings. Unlimited companies also have the benefit of less onerous reporting requirements.
For those who are likely to have increased tax liabilities on their property income because of the tax changes coming into effect, now is the time to review your ownership arrangements and consider your options. Not only are there options around the current tax changes, but it is a useful point to review broader family wealth plans.