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Summer Budget 2015 – Changes to Expenses Claimable Against Property Income

 

Property Investors Hit Hard

The following changes were proposed regarding what can be claimed as expenses against property income:
1. Restriction to the amount that a higher rate tax payer can reclaim on their mortgage interest against property lettings to 20% (only applies to residential property – not holiday lettings or commercial property).
2. Abolition of the ‘wear and tear’ allowance of 10% of income as it stands now.

 

How will these changes affect income from property in practice?

Higher or top rate tax payers with investment property, especially those who have higher debts financing the investment property, will be most effected due to the restriction on mortgage interest can be claimed.

At the moment the full amount of interest paid can be reclaimed, but the changes mean this will only be claimable at the basic tax rate of 20% in the future.

This could have a significant impact on the cash flow and profits from these investments.

 

Worked Example

Mr Maison is a higher rate tax payer and has a buy-to-let property with lettings income of £12,000 per year before expenses.

To keep things very simple let’s imagine there are no expenses to claim against this property income other than 10% wear and tear allowance, and mortgage interest of £6,000.

 

Profit and Loss account under the current rules as follows:

Income £12,000
Wear & Tear allowance (£1,200) NB claimable without incurring cost
Mortgage Interest (£6,000)

Taxable Profits £4,800

Tax due (at higher rate 40%) £1,920
Net cash after taxes £4,080 wear & tear added back – no cost

 

Now let’s look at the same income following the Budget changes:

Mr Maison doesn’t have any specific receipts for wear and tear items, so he is unable to claim anything for that.

And the mortgage interest of £6,000 is now will be capped to the basic rate of tax by 2020 (phasing in between now and then). So only 20% of will actually be claimable!

 

Profit and Loss once all Budget changes have taken effect:

£12,000 property income taxed at 40% £4,800 tax
Less new mortgage allowance of £6,000 x20% (£1,200)

Total tax due £3,600
Net cash after taxes £2,400

 

Comparison of taxes and net income:

…………                 Current Rules                         New Rules                      Difference

Tax Due                    £1,920                                £3,600                             + £1,680

Net Cash                  £4,080                               £2,400                              – £1,680

Even with one property, and a fairly modest amount of debt financing the investment the impact on tax payable and net cash is already very noticeable. For those with more property or higher debts this will obviously be even more significant.

 

When will these changes take effect?

The restriction to what can be claimed for mortgage interest will be phased in between April 2017 and April 2020.

Abolition of the current ‘wear and tear’ allowance is from April 2016.

 

Future planning for higher or top rate tax payers:

If you are thinking of investing in property as a long term ‘pension’ type investment you may wish to consider a Ltd company structure to do this.

A Ltd company will continue to be able to claim all interest from financing.

And tax for a Ltd company is currently 20% but reducing to 19% then 18% by 2020.

At the point of withdrawing funds from the Ltd there could be further tax if dividends withdrawn exceed £5,000. But if the object of the investment is for long term gain rather than present income this could be the best option.

However, the Ltd company structure isn’t going to suit everyone. You must consider your personal circumstances and objectives in deciding how to set up a property investment.

 

Can I move my existing portfolio into a Ltd company?

It’s unlikely you will be able to do this without incurring Capital Gains Tax on the disposal of the asset (as an individual).

The tax charge triggered for the individual may be difficult to fund given that the property portfolio has been transferred to another entity.

Incorporation relief may be possible on portfolios transferred if it can be shown to be a trading business rather than for investment purposes. However, in practice this relief could be limited.

 

Alternatives for investing in property?

Already there are schemes out there where individuals can invest in property via an investment platform.

These are already an attractive option for people wanting to invest in property but without the capital to ‘go it alone’.

I suspect that more of these schemes will be launched and become much more attractive to individuals who wish to invest in property without having to deal with the tax issues, or even establishing a formal structure themselves…

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