Economy & Investment News
Following the Conservatives’ majority victory in the general election, the Chancellor’s emergency summer budget on 8th July 2015 surprised many with the introduction of some significant changes to the taxation of residential property for buy-to-let investors.
Not only do these changes directly impact on individual landlords, but it’s Manors’ view that they are unlikely to get to the root of the housing problem in London and solve the chronic shortage of housing stock, particularly at the affordable end of the market. Instead, the recent tax changes are likely to lead to rent rises making it harder than ever for first-time buyers to save for a deposit.
It’s true that London’s Mayor, Boris Johnson, is making efforts to address the chronic lack of affordable housing stock in London by identifying brownfield sites and turning old government and NHS buildings into residential properties. The Chancellor, George Osborne, has also asked government departments to identify public sector land that can be sold off to help create new homes. However, with London’s population bursting at the seams, it’s highly debatable whether these initiatives are enough to help large numbers of first-time buyers get on the housing ladder.
So, what are the main changes introduced in the summer budget and how will they impact on investors and the wider property market? Here we examine them in turn:
Finance costs (including mortgage interest relief)
Buy-to-let investors can currently claim tax relief on the mortgage interest and other finance costs they pay as a deduction against the gross rental income when calculating their profit for taxation purposes. However, with effect from 6 April 2017 the amount of mortgage interest that can be claimed will be gradually reduced, to ensure that ultimately only basic rate relief is obtained on the finance costs. The new rules will be phased in as follows:
- in 2017-18 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction.
- in 2018-19 a deduction of 50% of finance costs and 50% given as a basic rate tax reduction.
- in 2019-20 a deduction of 25% of finance costs and 75% given as a basic rate tax reduction.
- from 2020-21 all financing costs incurred by a landlord will be given as a basic rate tax reduction.
At present, it’s estimated that 63% of all rented homes are mortgage-free, so these changes will only impact on 37% of rental properties. Those hit hardest by the changes will be small landlords rather than landlords with a large portfolio of properties and they are highly likely to raise their rents as a consequence to avoid making an overall loss. This view is supported by a survey of landlords carried out by the Resident Landlord Association which recently found that 65% of landlords are considering increasing rents as a direct result of the recent budgetary changes.
The reduction in tax breaks for landlords will certainly make buy-to-let a much less attractive proposition for investors who require a mortgage and could ultimately discourage investment in the sector and reduce the amount of rental stock available, which in turn will drive rents up. It’s a further concern for individual buy-to-let investors that these changes will start coming into effect in 2017 when a rise in interest rates could well be on the cards, which will be a double blow.
For companies, there should be no restriction as all of the income remains taxable at the basic rate of 20%. Likewise, for offshore individuals whose exposure to UK income tax remains at the basic rate of 20%, there will not be any restriction on the tax relief for loan interest paid. This change will only affect offshore individual or joint owners who pay tax at the higher UK income tax rates (above the standard 20% rate) on part of their net rental income.
Wear and tear allowance
The current wear and tear allowance enables landlords who let out a furnished property to deduct 10% of the gross rent in computing their tax liability, less any costs or utilities that would ordinarily be borne by the tenant. However the UK government has announced that this relief will be withdrawn from April 2016 and instead a new basis for landlords to claim the cost of renewing capital items will be introduced. The government will consult on this matter shortly and we await the outcome with interest.
Changes to inheritance tax
The UK government has made sweeping changes to the UK tax regime for individuals who are not domiciled in the UK. Until now, non-domiciled individuals have only been exposed to UK inheritance tax on their UK-situated assets.
For many people, purchasing an investment property using a non-UK company was relatively standard tax planning as it reduced the liability to income tax and also provided an exemption from UK inheritance tax, since the property would be owned by the offshore company and not directly by the investor. This interposition of an offshore company was sufficient to remove the property from the individual’s estate for UK inheritance tax purposes.
From April 2017, the UK government has announced that all UK property, whether directly or indirectly held by foreign domiciled persons, will be liable to UK inheritance tax. This includes any properties owned by a company, a trust or a hybrid structure using both a trust and a company.
The UK government introduced the annual tax on enveloped dwelling (ATED) charge in the Finance Act 2013 as a disincentive for people to acquire properties in a corporate wrapper where the property was to be occupied personally, i.e. not let out to third parties. A number of tax charges followed as a result, including stamp duty land tax at a rate of 15%, an annual charge based on the value of the property and capital gains tax (CGT) at a rate of 28%.
With the removal of the inheritance tax benefit of using a corporate structure, those individuals caught by ATED (currently properties worth more than £1million but decreasing to £500,000 from April 2016) may wish to unwind their structure to avoid the annual charges but they need to be mindful of the CGT consequences of doing so and professional advice should be sought.
For those individuals who are not caught under the ATED rules but still own UK residential property via a corporate structure, whilst the loss of the inheritance tax benefit is a major blow, it does not mean that that a UK company is not necessarily still the best vehicle to fund UK property acquisitions.
The UK government acknowledges that there may well be tax consequences for investors in unwinding a corporate structure and intends to publish a consultation on the new rules later this summer.
For UK residents, the good news is that parents and grandparents will be able to leave homes worth £850,000 to their children without them paying inheritance tax from 2017, rising to £1million by 2020. The move, first pledged as part of the Conservative Party pre-election manifesto, means that once fully in motion, each parent will be able to leave £500,000 in property – up from the current £325,000 per person – without paying the tax. As allowances can be passed from one deceased partner to the other, when the first dies, their £500,000 allowance transfers to the other, giving the survivor a £1million allowance.
In summary, the summer budget has a number of implications for the property market. While it appears to have hit small investors the hardest, it doesn’t look as if it’s necessarily going to help first-time buyers get on the housing ladder either, since rents may well rise as a consequence. How these measures will ultimately affect properties to let in Marylebone, which isn’t generally a magnet for first-time buyers due to the area’s high property prices, and the wider rental market in prime central London remains to be seen. As residential lettings in W1 is a core speciality of ours, at Manors one thing is certain. We will be keeping a close eye on the situation to ensure we remain fully informed and continue to be able to offer our clients constructive and impartial advice when it comes to selling or letting a property in Marylebone and surrounding areas.