Changes to tax rules for landlords

09 September 2015

Many private landlords will be hit with higher tax following the changes announced in the Summer Budget. What should those affected do to soften the blow?

The potential changes to the deduction of finance costs and the wear and tear allowance will impact many private landlords. As with the other key announcements on dividends and pensions, the changes to the deductions available for finance costs for private landlords will only hit those who pay tax at the higher or top rates of tax. The Government says this will affect around 20 per cent of landlords and raise at least £665m per year in extra tax.

The changes to wear and tear allowance will hit all landlords but, in some instances, is just a timing difference on the deduction.

Our technical briefing on the changes covers what is likely to happen but what actions, if any, are needed should be considered now?

Finance cost changes

Landlords likely to be caught by the proposed changes should be considering:

  • Whether it is now worthwhile reducing financing costs – The difference between reducing borrowing, and therefore finance costs, compared to the return on investments should be considered. With an extra 20 per cent or 25 per cent (and in some rare cases 40 per cent) tax on the amount of the finance costs, it may now be better to repay borrowings rather than keep investments. Investment advice should be taken.

  • Ownership of the property – If held in a sole name, it may be better to transfer property to a spouse or civil partner either entirely or in part. While this should be free of capital gains tax and inheritance tax, a stamp duty land tax liability could still arise. It may even be worth considering transferring property in whole or in part to adult children – again, there may other taxes due in doing so, but the income tax and future inheritance tax savings may make it worthwhile.

  • Consider a company – For some landlords it may be worth considering transferring their activities to, or carrying out new property acquisitions in, a company. For landlords with many properties, they could qualify for incorporation relief which could significantly reduce any tax cost of transferring their property business to a company. Companies only pay tax at 20 per cent (and this rate is expected to reduce in the future), so the impact of finance cost restrictions will be greatly limited.

Wear and tear allowance

The current wear and tear allowance for furnished rental properties provides an allowance to cover the cost incurred by landlords in replacing furnishings, rather than giving a specific allowance when replacements are made.

Landlords who rarely replace furnishings will have benefited from this, therefore the new rules may well be fairer as the deduction is intended to be given in the year that actual renewals are made. 

Given the announcement, it would seem to make sense that replacement furnishings are delayed until the new regime is in place. The wear and tear allowance should be available up to the end of the current tax year, with a deduction then being available for any new furnishings acquired.

It is expected that the new rules will be effective from 6 April 2016, but draft legislation will not be available until later this year. Therefore, while it is good to discuss the likely options available, any action should only be taken once we are clear on the rules.

For further information on the tax changes impacting landlords, please contact Gary Heynes or your usual RSM adviser.