New interest restriction rules are due to take effect in April 2017 and in the worst case scenario they could mean that some individual B2L landlords are forced to pay tax even when they make a loss.
While this seems incredibly unfair, particularly as it comes on top of other recent changes that have undermined profitability, landlords shouldn’t act in a knee-jerk way. Although it may seem like the odds are stacked against them, some simple restructuring of their portfolio, combined with tax planning advice, could be all that’s needed.
The interest restriction rules will be phased in over four years. In 2017/18, 25% of any interest or other finance costs related to landlords’ borrowings will become non-deductible when calculating taxable profit. This figure will rise to 50% in 2018/19 and 75% the following year. By 2020/21, all such costs will be ineligible for tax relief.
Importantly, the interest restriction rules will only apply to individual landlords and it is expected that some might choose to transfer their property into a company to avoid the punitive tax changes. However, taking this action could trigger a Capital Gains Tax (CGT) liability and, depending on how long the landlord has owned the property, and how much it is has risen in value over that time, the transfer of ownership may not be cost effective. In addition to CGT, Stamp Duty Land Tax (SDLT) is likely to apply, including the 3% surcharge, which was introduced in April this year.
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For some individual landlords however, incorporation could be a tax efficient solution, especially if he or she can demonstrate that they are running their property portfolio as a business, rather than as an investment. In this case they may be eligible for incorporation relief, which effectively defers any CGT liability to the date when the property is eventually sold by the company.
While there is no definitive guidance available from HMRC, case law indicates that landlords would need to be spending a minimum of 20 hours per week actively managing their portfolios to qualify for such relief. To substantiate a claim, they would need to maintain comprehensive records of the work they are doing to demonstrate they are actively managing their property portfolios. This could include activities such as collecting rent, administering new tenancies and liaising with workmen in respect of property repairs .
Higher-rate payers affected most
Before deciding on any course of action, B2L landlords should take a close look at their property portfolios and forecast the impact of the incoming interest restrictions as accurately as possible. While basic rate tax payers may find they are largely unaffected, higher-rate tax payers may need to consider whether their portfolio is still viable and explore their options carefully.
Some relatively simple changes such as refinancing investments and altering the split of ownership with a spouse could help to optimise profits. Incorporation should also be considered, particularly if the landlord does not have a full-time job and is spending much of their time looking after the properties. In any event, professional advice should be sought before any decisions are made.
There is no doubt that profiting from a property portfolio is becoming more difficult for all B2L landlords – individuals and businesses – and further costly changes, such as the expected ban on letting agent fees could make matters worse. However, by planning ahead, many landlords will be able to make the most of their investments and run successful and highly-profitable businesses.