November 2017

Buy to Let Tax Traps - What you need to know

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The rapid growth of buy-to-let has seen the number of private landlords reach almost 2 million owning 1 in 5 homes worth £1 trillion*.

However against this backdrop the Government has been making life more expensive for landlords taxing them at every step from mortgage to purchase and ongoing letting through to sale.

As a result landlords need to be wary of potential tax traps when dealing with buy to let and / or second homes.  Here are three to look out for:

Reduction in tax relief

Changes in the taxation of buy-to-let properties could leave landlords facing much higher tax bills. Under the reforms introduced in April this year tax relief on residential property finance costs is being restricted from a landlord’s highest marginal tax rate down to the basic rate of tax over the next four years. This could increase a landlord’s property profits (aka taxable income) significantly meaning that apart from paying increased income tax many will be pushed into higher rate tax and various tax traps.

Take for example a landlord earning £45,000 pa, plus receiving £12,000 in rental income and paying out £2,000 in maintenance costs plus £6,000 mortgage interest. The calculation of their property profits/taxable income and income tax could change significantly.

Tax year

Rental income

Costs

Mortgage Interest

Property profits

Tax @40%

Basic rate tax relief reducer

Overall tax

2016/17

£12,000

£2,000

£6,000

£4,000

£1,600

-

£1,600

2017/18

£12,000

£2,000

(£6k*75%)

£5,500

£2,200

(£6k*25%)*20%

£1,900

2018/19

£12,000

£2,000

(£6k*50%)

£7,000

£2,800

(£6k*50%)*20%

£2,200

2019/20

£12,000

£2,000

(£6k*25%)

£8,500

£3,400

(£6k*75%)*20%

£2,500

2020/21

£12,000

£2,000

0

£10,000

£4,000

£6k*20%

£2,800

In this instance not only will their annual income tax liability have increased by £1,200 by 2020/21 (the difference between higher and basic rate tax relief), but because of the change in the calculation their taxable income will have soared by 250% to £10,000.

Whilst some landlords may consider moving their portfolio into a limited company to sidestep this and some of the other tax changes this can be a minefield fraught with alternative taxes and costs.

Child benefit tax trap

As their taxable income increases from the buy-to-let tax changes landlords could also fall into the child benefit tax trap. Using the above example again if the landlord was married with three children claiming child benefit of £2,501pa the ‘high income child benefit tax charge’ would now apply as their total taxable income would be £55,000 meaning they would lose £1,250 child benefit (1% for each £100 in excess of £50,000) making a total tax increase of £2,450pa from 2020/21. And don’t forget the personal allowance and tapered pensions annual allowance tax traps could apply at higher income levels.

To avoid this tax planning opportunities include transferring the property and rental income to a spouse/civil partner or making a personal pension contribution.

Inheritance Tax (IHT) increases

With so many other tax changes afoot landlords could have overlooked the IHT liability they will be building up which is unlikely to be covered by the new residence nil-rate band (unless the property was previously a main residence).

Property prices have continued to rise with the average UK house price in June 2017 being £218,390 – some 41% higher than their low point in April 2009 * and substantially higher in central London and other UK capital cities – stoking IHT liabilities for landlords.

Potentially exempt transfers

To avoid IHT some landlords may have made outright gifts (or be considering gifting) of second properties to adult children. However whilst taking care not to give rise to a gift with reservation of benefit or trigger pre-owned assets tax they may have overlooked the fact that this is a potentially exempt transfer (PET) for IHT purposes. 

Should they die within seven years the transfer will use up the donor’s nil-rate band first increasing IHT by up to £130,000.

To discuss the possible solutions to these and any of your financial planning issues please do not hesitate to contact us.

 

*Sources: HomeLet and Telegraph, Halifax HPI 7/7/17

This Briefing Note is provided for information purposes only and does not constitute any form of financial or investment advice. We believe the information to be correct at the time of going to press but we cannot accept any responsibility for any loss to any person as a result of action or refraining from action as a result of any item herein.

Printed and published by ©Holborn Financial Limited authorised & regulated by the Financial Conduct Authority. September 2017