With the second phase of Section 24 of the Finance (No. 2) Act 2015 now in motion, the buy-to-let sector is bracing itself for yet another shock to the system.

First in line for punishment are the heavily geared sole-trader Landlords operating within higher or additional taxpaying thresholds.  Then there are those unwittingly being pushed into the high tax bracket due to their inability to deduct a further 25% of mortgage interest costs.  Although the 20% mortgage cost credit may attenuate some of the damage, these situations are likely to worsen in the coming years as the Section 24 screws are tightened.

With the Chancellor’s priorities clearly elsewhere, most of the sector has now come to terms with the fact that any chances of top-down reform are slim – at least for the foreseeable future.  As a result, over the last couple of years, the wider discussion surrounding Section 24 has encouraged more landlords to scrutinise their imminent tax positions and plan in the most appropriate manner.

To help landlord-investors ensure they’re on the right track, this extended post collates a wide range of invaluable commentary from professional accountants and tax advisors actively working in the buy-to-let industry.  The contributions have delved into the specifics of the legislation itself, incorporation / restructuring existing Property holdings, reducing debt exposure, tax-efficient exit strategies, amongst several other relevant topics.

Further down, prominent mortgage brokers and finance specialists also discuss how the buy-to-let lending landscape is responding to Section 24 and how the Prudential Regulation Authority (PRA) criteria is affecting the sector as a whole.

Click on the links in the contents box below to automatically scroll to the specific commentary link of your choice. You will also see an arrow towards the right which can be used to return to the top of the post.  Please also read this disclaimer.

The Property Investor’s Blog (PS Investor Services) would like to thank all contributors for their input and encourage readers to contact them individually for more specific advice.

Please Read Our Disclaimer

The contents of this blog post do not constitute tax advice. Independent professional advice must be sought before any tax planning, which will differ according to your individual circumstances.

The Property Investor´s Blog and PS Investor Services are not qualified accountants, taxation or financial advisors. Whilst the contributors have attempted to accurate up to date and complete content, all information provided should be regarded as an indicator and not to be relied on as a statement of recommendation or representation of fact.

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Director of Hoffman & Cohen, Nasir Shaikh (FCCA)

“Investing in property has always been quite lucrative, considering the security it brings to the investment added with the reasonably secured yield you may earn on your rental income.  I personally know a number of wealthy individuals who made most of their wealth by investing in properties.

We are living in a world, where the Treasury feels that the UK has made enough property millionaires and thus have introduced section 24 to limit the number of property tycoons or to create a fairer system or is to increase the wealth of the treasury?

What is Section 24?

In simple words, section 24 is in place to restrict finance cost relief for individual landlords.

What does this mean?

This means that landlords will no longer be able to deduct their interest costs from their gross property income before calculating their tax liability. Instead, the landlords will have to calculate their tax liability, without deducting the interest they paid on the mortgage. Once the pre-finance cost liability is calculated, the landlord will then deduct an amount from their tax liability, which equals to 20 percent of their interest costs

Confused?

I am aware how confusing this sounds so let’s use an example…

Let’s say you have a rental income of £100,000 (no other income) and you pay interest on the mortgage of £20,000.

Before Restrictions

As per the older rules, your income before personal allowance would be £80,000 (£100,000 – £20,000). You are allowed £11,500 in personal allowance (2017/18), which means that you will pay tax on £68,500 (£80,000 – £11,500). The total tax you will pay would be £20,700

After Restrictions (2020 – 2021)

From the year 2020/21, your total income would become £100,000 as you will no longer be allowed to deduct any mortgage cost. For comparison purposes, if we use the same allowance of £11,500 then you will end up paying tax on £88,500. The total tax you will pay would be £24,700

In a simple nutshell, instead of going on your yearly holiday you will now fork out an extra £4,000 while sipping a cuppa…

There has got to be a solution, right?

Let’s compare the above scenario to a scenario where all your properties are under a limited company. The company would have the rental income of £100,000 and will be able to deduct the entire interest cost of £20,000. As you will be actively involved in running the company, which is why you may also be able to withdraw a salary of £8,060, which means that the company profits will look as follows:

Rental Income – £100,000

Less: Finance Cost – £20,000

Less: Your Salary – £8,060

Total Profits – £71,940

The company will pay a tax of 19% (further to be reduced to 17%) on the above profits, which will be £13,668.

Let’s assume that you will withdraw the entire profits after tax of £58,271 in dividends than you will end up paying a further tax of £8,795.50.

Here is the comparison:

Tax after restriction – £24,700

Tax via LTD – £22,463.50

Savings – £2,236.50

Is this saving worth the extra complications?

Absolutely, because a Limited Company allows you the flexibility of tax planning by reducing the amount of dividends you could withdraw to reduce your tax liability. If you decide to withdraw only £36,940 in dividends than the total tax under Limited Company option (company and personal) would only be £16,180.

Is the savings of £8,519.50 worth it?

Not yet…

For the starter, banks usually charge more in interest when taking the mortgage through the limited company plus their application fees are generally higher, which could potentially wipe out the entire savings.

I am currently exploring the options of how to retain the mortgage on your personal name while transferring the property to a limited company.  The reason I said ‘exploring’ is because, as an award-winning Chartered Certified Accountant, I do not want to associate myself with any tax avoidance schemes and would rather prefer to find ways that can legally save my clients in taxes instead of using wishy-washy techniques that may end up landing them with huge tax bills.

The options that I am currently exploring are as follows:

1. Firstly, I would suggest getting this structure pre-approved by HMRC to ensure that it does not fall under tax avoidance;
2. You will transfer your rental business to the limited company, in return for the shares by using a business sale agreement deed. You will remain as the legal owners of the properties and no disposal of properties will take place but the beneficial interest would be transferred to the company;
3. A second deed will transfer the beneficial interest of the entire business to the company;
4. You will have an agreement with the company, where the company will be responsible to pay you the mortgage, which you will then pay to the bank as an agent.

In summary, you will remain the legal owner of the properties i.e. banks will be satisfied and the company will become the beneficial owner of the property i.e. will pay taxes on the income to HMRC.

Would bank approve the above transaction?

There is no simple answer to this question as this will depend upon their mortgage terms and if the term does not stop you to transfer the beneficial ownership than the bank cannot stop you as you will remain the legal owner.

What about Stamp Duty?

As discussed above, there would be no change in legal ownership of the property, which is why no notification is required to HM Land and Registry. This will however still trigger SDLT unless if the properties are owned by 2 or more individuals involved in a property rental business i.e. partnership may exist under the partnership act 1980 (even if the partnership is not registered with HMRC). If HMRC approves that the partnership exists than the properties could be transferred from a partnership to a company without attracting SDLT. This should again be pre-approved by HMRC to ensure that this does not fall under tax avoidance.

What about Capital Gains Tax?

The transfer of a business into a company would technically be a transfer for tax purposes at the market value and Capital Gains Tax should apply. However, incorporation relief could be used, which means that the gains inherent in the properties at the time of transfer into the CGT base cost of the shares. The gain is thus brought back into charge if and when the shares are disposed of.

Summary

Transferring your existing property portfolio to a limited company could prove to be a very lucrative option especially for property-rich landlords. As explained above that it may not be very straightforward which is why you must speak to your tax adviser who should look into the following:

1. Would the above structure be beneficial for you from the tax point of view?
2. If yes then can your tax adviser assist you with non-statutory clearance from HMRC to ensure no capital gains tax or SDLT is payable. Your tax adviser must be experienced and willing to get into lengthy negotiations with HMRC;
3. If yes then do you have a legal advisor who can assist you with the deeds. It is very important that correct deeds are in place to make sure that the mortgage payment from the company to you is not constituted as income;
4. Are the hassle and cost worth in comparison to the tax savings?

As explained above that the tax savings in itself could be very lucrative to at least look into this option. It is extremely important to ensure that pre-approvals from HMRC are sought and proper tax and legal advice are given by your advisers.

You have to bear in mind that the tax law is constantly changing and I will not be surprised if the Government comes up with a proposal to restrict the finance costs incurred by the companies associated with property rental business or decide to disallow the non-statutory clearances.  In the end, we are in business to ensure that we pay the correct taxes the legislation allows us and explore any legal avenues that best suits our needs.”

Nasir Shaikh @Nasir_Acca_DN – Director and Chartered Certified Accountant (FCCA), Hoffman & Cohen (email: [email protected])

Director of Rita 4 Rent, Michael Wright

“2018 will be the year where affected landlords finally see the first effects of Section 24, given the 2017/18 tax year is the first period of the 4-year equal phase in. Whilst the full effects will not be felt until the rules fully implement in 2020, now is the time to review your position, and ensure you have an excellent strategy moving forward.

Whilst Section 24 is a threat to the market, there are plenty of opportunities to counter this, and it is key to find the best strategy to suit your own circumstances. It is fair to say that landlords are understanding the need for action, reflected in a steady increase in our client base as we work together for best advantage in the future.

It is being seen by many as a period of gloom, but there are positives out there. There will be some landlords benefitting from different structures and strategies, but overall, more landlords are becoming more professional which is certainly a positive for the industry.”

Michael Wright @Rita4Rent – Director, Rita 4 Rent (email: [email protected])

Founder of the Tax Café, Nick Braun

“We’re almost into Year 2 of the ‘Big Landlord Tax Grab’ – the cruelest and badly thought out tax change I have come across since writing my first article in 1989.

It’s the sort of tax change you would expect from the Loony Left, not from a Conservative Chancellor like George Osborne (the man who introduced it).

I am, of course, talking about the restriction to tax relief on residential landlords’ interest and other finance costs – known as ‘Clause 24’ or ‘Section 24’ because it is contained in Section 24 of the 2015 Finance Act.

When the change was announced the Government said it was targeting ‘wealthier landlords’ but in reality, those most affected are landlords who simply aspire to be wealthy: those who own a lot of rental properties but also have a lot of mortgage debt.

Groups of landlords have lobbied for the scrapping of the legislation on the grounds that it is, in fact, a tax on tenants (because landlords will simply pass on the tax increase by upping the rent they charge).

I have always felt that policymakers would view this argument as disingenuous and never held out much hope that there would be a change of heart. Clause 24 is all about landlords and there is very little public sympathy for landlords.

Nevertheless, the legislation is incredibly unfair because it goes against the fundamental principle that businesses should be able to deduct all of their day-to-day expenses when calculating their taxable profits.

With their interest costs no longer tax deductible many, landlords will pay 40% tax on a bigger chunk of their income.

They will then receive a basic-rate ‘tax reduction’. Essentially what this means is an amount equal to 20% of your interest costs will be deducted from your final tax bill.

So instead of getting 40% tax relief on your finance costs, you will get 20% tax relief – i.e. your tax relief will be halved.

As their taxable incomes increase some will face additional tax stings, including loss of the family’s child benefit (when income rises above £50,000), withdrawal of their personal allowance (when income rises above £100,000) and paying the 45% additional rate (when income rises above £150,000).

The Timetable for Section 24

The tax change is being phased in over four years. We’re now coming to the end of Year 1 (the 2017/18 tax year), although most landlords will only feel the pinch when they submit their tax returns, possibly as late as January 2019.

For 2017/18 only one quarter of your finance costs are disallowed so the impact on most is small, although you may also have to make an additional payment on account when you submit your tax return.

From the start of the 2018/19 tax year on 6 April 2018 half your finance costs will be disallowed.

If you’re a higher-rate taxpayer you can make a very rough estimate of how much extra tax you’ll pay in 2018/19 because of the tax change by multiplying your total finance costs by 10%.

Thus, if your total finance costs are £10,000, your tax bill will increase by £1,000 (£10,000 x 10%).

Note, here we are comparing 2018/19 tax bills with pre 6 April 2017 tax bills (i.e. before the interest relief restriction started to bite).

If you are a basic-rate taxpayer in 2018/19, despite the fact that half your interest costs will no longer be tax deductible, you will have no extra tax to pay.

It’s important to stress that this rough and ready estimate cannot be relied on by all taxpayers. If you end up in a higher tax bracket because half your interest is no longer tax deductible, you could face a higher tax bill:

Example

Katerina is a full-time landlord. After deducting all of her expenses (except interest) she has a net rental income of £125,000. Her interest payments are £75,000. She also receives around £2,500 in child benefit and is the highest earner in her household.

In 2016/17 (when all of her interest was allowed) her taxable rental profit was £50,000 and her income tax bill was £9,200.

This year (2017/18) one quarter of her interest (£18,750) is disallowed so her taxable income increases to £68,750. The income tax payable is £16,200 plus a £2,500 child benefit charge less a £3,750 tax reduction for disallowed interest (£18,750 x 20%). Her tax bill rises to £14,950.

Next year (2018/19) half her interest (£37,500) will be disallowed so her taxable income will increase to £87,500. The income tax payable will be £23,360 plus a £2,500 child benefit charge less a £7,500 tax reduction for disallowed interest (£37,500 x 20%). Her tax bill rises to £18,360.

Katerina’s tax bill increases from £9,200 to £14,950 and then to £18,360.

In 2019/20 three quarters of her finance costs will be disallowed and in 2020/21 all of her finance costs will be disallowed. She will then see her taxable income rise to £125,000 and will probably also lose all of her personal allowance.

You may be interested to know that, if Clause 24 had never been introduced, Katerina would have been left with an after-tax income of £45,000 in 2020/21. Thanks to this tax change, however, her income will fall by 50% to £22,500.

Planning for the Change

There are lots of things landlords can do to beat the tax increase. Some are relatively simple, others are more drastic:

• Increasing rent. As a very general rule of thumb, if you’re a higher-rate taxpayer you can calculate the extra rent you will need to charge by 2020/21 by multiplying your interest bill by one third;
• Postponing tax-deductible spending. For example, if you expect to be a basic-rate taxpayer in 2018/19 (when 50% of your interest is no longer tax deductible) but a higher-rate taxpayer in 2019/20 (when 75% will no longer be deductible) it may be possible to save tax by postponing spending on things like replacement kitchens until 2019/20;
• Increasing tax-deductible spending. This includes paying family members who help you in the business and claiming all the little things you may have overlooked (e.g. motor expenses and home office costs);
• Pension contributions. It is possible to claw back all the extra tax you will pay by making pension contributions, where possible. As a very general rule of thumb, your gross pension contributions will need to be half as big as your non-deductible interest;
• Reducing debt. As the tax relief on your mortgages is reduced it may become more sensible to pay off this debt rather than, for example, the mortgage over your own home, especially if the interest rate charged on your rental properties is significantly higher;
• Selling property. Now we’re into the more drastic measures. It’s unlikely many landlords will take the “nuclear option” and sell their properties as their mortgage tax relief is reduced. You may end up with a big capital gains tax bill instead. Many will be prepared to pay more income tax in the hope of enjoying even more capital growth in the future. However, those with large portfolios with lots of debt may suffer such a sharp decline in income they may be forced to sell;
• Emigration. If you retire abroad or work abroad you will still pay tax on your UK rental income but if you have no other income taxable in the UK there’s a good chance you will be a basic-rate taxpayer and therefore unaffected by the reduction in tax relief on your finance costs;
• Transferring properties to your spouse. May work if your spouse is in a lower tax bracket than you. Potential stamp duty cost if your spouse assumes responsibility for an existing mortgage;
• Using a Company. Companies are not affected by the tax change and have lots of benefits and drawbacks. Benefits include paying tax at just 17%, drawbacks include the potential double tax charge when funds are withdrawn. An attractive solution for those thinking of buying new properties but more difficult to get existing properties into a company without incurring tax charges.

Nick Braun – Founder of the Tax Café which publishes several tax guides for landlords including Landlord Interest, How to Save Property Tax and Using a Property Company to Save Tax (email: [email protected])

Business Development Manager at Optimise Accountants, Simon Misiewicz

“Ever since our budget article was written in July 2015, we’ve constantly looked at the negative impact that mortgage interest relief will have on people’s financial and tax affairs. We’ve also spent a lot of time to identify the solutions to mitigate the impact of Section 24’s mortgage interest relief for our investor clients across the UK.

Section 24: Basic rate taxpayers becoming high rate taxpayers

As you will see from the above, this person has moved from being a basic rate taxpayer to being a high rate tax payer from 2020/21 because of the mortgage interest relief cap. This means that the top rate of tax the above person will pay now becomes 40% rather than 20% before the tax changes.

Section 24 impact: Loss of child benefit

If the person was claiming child benefit allowance they would be asked by HMRC to repay this. Child benefit may be claimed by individuals with children that earn typically less than £50,000.

As Section 24 would now show a greater level of income for many property investors there is a risk that the child benefit would need to be paid back.

Section 24 impact: Loss of personal allowance

Some of you reading this will see that the person above has a taxable income of £95,000.

However, once the Budget announcement changes kick in (mortgage interest relief) fully the taxable income will be restated as £130,000. This means that the person will lose their personal allowance.

If you earn more than £100,000 then you will be aware that your personal allowances are being eroded by £1 for every £2 of earnings above £100,000.

Someone that earns £120,000 would lose an element of their personal allowance, as follows:

• £20,000 Excess of earnings limit = (£120,000 earnings less the £100,000 limit);
• £10,000 Reduction to personal allowance (£20,000 excess divided by 2);
• £1,500 Revised personal allowance (£11,500 less £10,000).

Section 24 impact: Loss of pension allowance

In the above example, you will see that their earnings have increased from £95,000 to £130,000. This also means that the person above will start to lose the pension contributions allowance.

You usually pay tax if savings in your pension pot goes above the annual allowance.

As shown on the Government website, from April 2016 you’ll have a reduced (‘tapered’’ annual allowance if both the following apply:

• Your ‘threshold income’ is over £110,000 – this is your income excluding any pension contributions (unless they’re paid as a salary sacrifice by your employer);
• Your ‘adjusted income’ is over £150,000 – this is your income added to any pension contributions you or your employer make.

For every £2 over the above-mentioned amounts, you will see a reduction of £1 to your pension contribution allowance.

What changes are we likely to see post Section 24?

I haven’t seen a slowdown in the maintenance and growth of property investment in 2018 from my landlord clients, but a more cautious property investment sector could see slight changes this year.

The majority of landlords I’m working with are planning on maintaining existing portfolios, but many others are looking to sell buy-to-let properties to simplify their tax liabilities from 2018.

Other property investors are reviewing the UK market and looking at new and upcoming buy-to-let locations in the North, where the market is proving more resilient to recent changes in the sector.

I’ve noticed in the last financial quarter that a lot of property investor clients appear to be looking to invest in Limited Companies as vehicles for growing their property businesses – this remains a sound idea.

At the time of writing section 24 mortgage interest relief does not affect landlords that own properties inside a limited company.

Whilst reviewing industry recently, I noted an article discussing how sales from buy-to-let landlords looking to reduce their portfolios would be swelling the Treasury coffers, with billions of pounds being hands over in Capital Gains Tax (CGT) payments. Receipts are expected to rise by 5% to £8.8bn in the current 2017/18 tax year, and surging on to hit £10bn in the next tax year.

There are a number of solutions that we have identified for our clients:

• Buy any new buy-to-let properties in a Limited Company if you are a high rate taxpayer;
• Pay down the mortgages in your own name. A reduction in debt will also see a reduction in mortgage interest and the impact of Section 24;
• Review the portfolio as a whole and start to sell properties that make a small profit now that will inevitably start to make a loss once Section 24 is in full force;
• Look at the income for both husband/wife and civil partnerships to see if income may be reallocated to the lower earner. There is also an opportunity for them to review all taxable income including their jobs. We have seen a few clients that have built up a property portfolio giving up their employment.

How does Section 24 affect you?

We have created a Section 24 spreadsheet that you can download for free. This will help you understand if the tax changes will affect and how much more tax you will need to pay in the next few years.

Conclusion

There are many landlords that are not aware of Section 24 according to the National Landlords Association (NLA) never mind the impact that it will have on their tax position. I do not believe that we will see too much movement until we enter the second year of Section 24 when people start to see the real impact.

Section 24 will have an impact and many landlords will eventually sell their properties especially as local authorities increase the amount of legislation. HMRC will reap the benefits either way as Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) will increase as the more accidental landlords dispose of their properties and income tax from investors that do not make any changes.

I believe that we will see buy to let properties being owned by professionals rather than the accidental landlords. This means there will be a lot more incorporated landlords. We have already started to seek clearance for many of our property investors that wish to incorporate their property business within a limited company. This is not going to be a simple process as HMRC clearance will need to be sought whilst having to refinance the property portfolio upon incorporation.

Serious property investors will adapt and change as they have always done. The accidental landlords will leave this market place. Section 24 will also decrease the competition whilst increasing the standard of homes being provided to tenants.”

Simon Misiewicz @Optimise_Tax – Business Development Manager, Optimise Accountants

Tax Consultant at Kreston Reeves, Jo White

Property investors – what are they doing now?

“A couple of years ago the Government announced a fundamental change in the way residential landlords would receive tax relief on their mortgage interest costs.  These rules, nicknamed ‘Section 24’, have meant that more and more landlords are reconsidering their position in the market and whether property investment is still right for them.

As an overview, the Section 24 (S.24) rules mean that from 6 April 2018 individuals will no longer be able to deduct their full interest costs when calculating their rental profits.  Instead, they will be taxed on a higher amount (gross rents less other allowable expenses).  Once their income tax liability has been calculated they will then be able to reduce this cost by 20% of the interest costs.  This adjustment is known as a tax reducer.  The tax reducer is calculated based on 20% of the lower of three amounts.  Where you cannot use your full interest costs in these calculations any excess can be carried forward to be included in future year’s calculations.

The rules are being phased in over a period of 4 years with the full impact of the changes being applied from 6 April 2021.  The new rules will, therefore, apply to 25% of the interest costs in 2018-19, 50% in 2019-20 and 25% in 2020-21.

What is apparent from these changes is there is not a ‘one size fits all’ approach to how landlords are assessing their options.  I have had discussions with some individuals who are sitting tight and also ones who are selling their entire portfolio, as they do not feel it is worth investing in this market anymore.

Before any decision can be made it is important that landlords forecast these changes and how they will impact on them.  This doesn’t just mean the additional tax liability year on year but also their cash-flow, to ensure the higher balancing payment due in January is factored into their calculations.  Most landlords will be on a payment on account system with HM Revenue & Customs.  This means they will be paying towards their next year’s tax liability based on the tax year just gone.  As their tax liability increases their payment on accounts will not be sufficient to cover the increased tax cost in the next tax year.  A further top-up payment (known as a balancing payment) will therefore be due, at least until 2020-21.

Once these forecasts have been prepared they can then be used to assess the impact of any decision they may make.  For example, if they decide to sell a property and pay down the mortgage on others, what will the lower interest costs and rental profits do to their overall cash-flow?

Landlords will be aware that a lot of discussion has been had as to the possible incorporation of property portfolios.  Many advisors out there are suggesting this as the option that will suit most clients’ profiles.  Whilst this may help save tax overall there are a number of factors to consider:

• Can you meet the relevant definitions to allow you to transfer the properties from your personal name to a company without incurring Capital Gains Tax or Stamp Duty Land Tax on the transfers?
• What is the overall intention for the portfolio? If it is full profit extraction then will the Income Tax saving be more than the Corporation Tax on profits, Income Tax on profit extraction and additional administrative costs?
• If the property portfolio is a shorter term investment what would the tax costs be of extracting the cash from the company once you have sold your properties?
• Is there any mortgage or other issues you need to consider? Is it OK to transfer the mortgages to the company?  Do you need the lender’s permission?  Will there be any additional finance costs in doing this?

Selling the property portfolio is also a step a number of individual landlords are considering.  Here you need to understand your Capital Gains Tax liability.  Questions I would be asking my clients would include:

• Do you have any properties with small gains that may be worth selling first?
• Can you sell the properties over a number of years? This will allow you to use multiple Annual Exemptions;
• Do you have any Capital Losses which you could utilise?
• Are any of the properties you hold subject to reliefs, such as Principle Private Residence Relief (PPR) allowing a proportion of the gain to be exempt from Capital Gains Tax?
• Once you have sold the properties what will you do with the sale proceeds? Is there an alternative investment which will result in the same income yield?

For landlords who are married or in a civil partnership, there may be some opportunities to use tax-free allowances or lower rate tax bands.  Whilst the transfer of properties between spouses/ civil partners are exempt from Capital Gains Tax, where there are mortgages on the properties then care will need to be taken as to any possible Stamp Duty Land Tax charge is a proportion of the debt was also assigned.

Other areas that landlords can consider would include:

• Possible restructuring of their debt – commercial properties are not subject to the new rules and therefore increasing their mortgage against these properties and paying down the residential let mortgages may help their position. Borrowing against other assets to pay down residential let mortgages could also be favourable;
• Increasing the rents – this would at least cover the additional tax cost from a cash-flow perspective however the higher rent will also be subject to Income Tax. They also need to be mindful of the increased financial burden on tenants and whether a rent increase would ultimately result in void periods on the property;
• Reducing your rental profits in other ways – if your portfolio is due to be renovated then additional repair costs could help reduce profits which in turn would reduce your tax burden. It doesn’t stop the new tax rules being applied but may restrict their impact;
• Benefiting from other tax reliefs – areas to consider would include pension contributions, gift-aid payments, and investment in Enterprise Investment Scheme or Seed Enterprise Investment scheme shares. These types of payments would either increase the amount of income that would be taxed at the basic rate (donations/ pension) or would reduce your tax liability (SEIS/ EIS investments).  These are true cash out-flows however so you need to weigh up the additional cost of the tax savings made.

Whichever option landlords ultimately decide, it is important they seek the correct advice whether from an accountant or tax advisor or FCA regulated financial planner or mortgage broker.

As mentioned above, there is no single answer for all landlords.  Any decision made will have result in a series of differences on your income, tax and cash-flow and therefore it is important to understand the overall impact before a decision is taken.”

Jo White @KrestonReeves – Tax Consultant at Kreston Reeves (email: [email protected])

Corporate Tax Director and Property Sector Specialist at Menzies LLP, Rebecca Wilkinson

How landlords can best prepare themselves in light of the further erosion to tax relief

“It is important to emphasise that these changes are not new, but part of a four-year programme that started being phased in from April 2017. Many landlords will already be taking steps to mitigate further erosion of tax relief. For the tax year 2018-19, the percentage of disallowed finance costs will increase to 50 percent. Some landlords may be looking at protecting their margins by putting up rents, however, this is unlikely to be commercially feasible in the majority of cases.

Paying off mortgage capital to reduce future finance costs may also be an option for some, helping to minimise the amount of interest payable in the long term. However, many landlords have interest-only mortgages because they do not have sufficient cash-flow to pay off loan capital. Selling off unprofitable properties and using the cash to reduce mortgage balances may be the only option for some, unless incorporation is a viable alternative.”

Insights on incorporation

“A key advantage of incorporation is that companies are still able to claim full tax relief for their mortgage interest, as the new rules apply only to individuals. However, unless specific conditions are met, incorporation could result in upfront Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) charges. Furthermore, it is worth bearing in mind that incorporation usually requires all properties to be re-mortgaged and borrowing rates for companies can be much higher than they are for individuals, which may outweigh any tax savings achieved.

Incorporation should be considered on a case by case basis. It is not suitable for all landlords. Previously, landlords and their advisers were able to apply to HMRC for non-statutory advance clearance on property incorporations if there was uncertainty over whether the conditions for obtaining CGT and SDLT relief were met. HMRC have recently tightened up on this service and are refusing to give clearance in the majority of cases. Whilst this does not mean that the reliefs will not apply, it does mean greater uncertainty for landlords looking to incorporate and it is therefore even more important to seek professional advice.”

Advice on selling properties to mitigate the effects of tax relief changes

“With the removal of tax relief likely to make it inefficient to hold on to certain properties, a number of landlords will be considering selling them instead. While it is important to be aware that this will incur a CGT liability, individuals may still find it a necessary step to manoeuvre into a more tax-efficient position.

Any landlord suffering increased tax charges should consider whether they can afford to meet this additional cost. As long as the additional tax can be paid, it may still be worth holding onto the properties for longer term capital growth. Examining each property in their portfolio will allow landlords to decide whether they can afford the increase in their tax liability or not.”

Best practice on setting up partnerships

“Partnerships can serve as a useful step towards incorporation because relief from SDLT can only be claimed on the incorporation of a partnership and not by landlords operating on their own. However, jointly owning properties does not necessarily mean that two landlords are in partnership together and professional advice should be sought on whether joint arrangements meet the definition of being a partnership.

It should also be noted that SDLT and CGT could arise on the formation of a partnership and if a partnership is formed for no other reason than avoiding SDLT on a later incorporation, anti-avoidance provisions could be applied to prevent the SDLT relief from applying.”

Strategies for landlords who may be at risk of being pushed into a higher tax band

“If a landlord’s spouse is paying tax at a lower rate, it may make sense to transfer a greater share of the beneficial ownership of a property portfolio to them rather than following the standard 50:50 ownership model. By doing this the lower rate taxpayer will be taxed on a greater share of the portfolio profit, reducing the overall tax rate.

However, landlords gifting beneficial ownership need to be aware that SDLT could be payable on the gift and should also be aware of the wider legal implications, as it means the other spouse will be entitled to a greater share of the capital value of the properties as well. Professional advice should be sought and the gift should be properly documented by a qualified solicitor.”

Rebecca Wilkinson @MenziesLLP – Corporate Tax Director and Property Sector Specialist at Menzies LLP (email: [email protected])

Director of Landlord Tax Services, Maurice Patry FCA

Section 24 – The problem with incorporation and the elephant in the room

“About 440,000 landlords will pay more tax by 2020 as a result of Section 24 of the Finance (No. 2) Act 2015 (Moneyfacts 20 Oct 2016). Some of them could find the tax bill exceeding their profits. This has been called the ‘Tenant Tax’ but will those landlords that are most affected really put up rents and risk pricing themselves out of the market by failing to compete with the other 1.3m private landlords in the UK who are not affected? (figure from HMRC). I suspect not.

When it comes to borrowing landlords can be split into four categories. A lot have no borrowing. (This group includes thousands of overseas investors).  Then there are those who have emigrated and are letting out the former family home, often with a small mortgage and just income from one property. And of course, there are those who just invest in one or two properties and whose income (even after disallowing interest) will not exceed the 20% tax band. Almost all of these will not be affected by Section 24. The fourth category is the professional landlord with a portfolio of property, often highly leveraged. They represent 20% to 25% of all private landlords.

So what is the answer for our professional landlord? There are few choices. The most frequent question we get asked is ‘should I put the portfolio into a company?  And the answer is that many have done so because they are attracted by the lower tax rate and no disallowance of mortgage interest. For a few, incorporation can work very well but for many, it won’t.

On the transfer of a property into a limited company the landlord makes a disposal potentially subject to Capital Gains Tax. And don’t forget the Stamp Duty. So the transfer in can be very expensive.

Selling a property held in a company to take the money out can also be very expensive. Sell an investment property that you own personally and you will pay a top rate of CGT of 28%. If the company sells it then the full rate of Corporation Tax will apply to the gain and when you take the money out of the company you could find that you pay a further 32.5% or 38.1% on most of the money (Higher and Additional rates on dividends).

When it comes to the income the most popular way to extract money is by way of dividend but the company will already have paid Corporation Tax on the profit that you take as a dividend and then you will pay further tax at the rate of tax appropriate to the dividend unless it is under £5,000.

Incorporation can work well for those who invest for the long-term and who will draw money out of the company when their other income has dropped, as it will at retirement. But they are taking a high risk when one considers possible future government interference.

But no one is talking about the elephant in the room: we have seen the government bring foreign investors into the capital gains tax net; we have seen small foreign companies holding UK investment property brought within the inheritance tax net; we have seen the introduction of Annual Tax on Enveloped Dwellings (ATED) and the increase in Stamp Duty rates; and of course Section 24. It is a very small jump to seeing companies holding small portfolios being made subject to Section 24, and then what happens if we have a change of Government, even less enthusiastic about the private landlord?

I worry for those professional landlords who have had a knee-jerk reaction to Section 24 and incorporated. Reversing incorporation could be very expensive. Perhaps the answer is to accept that Section 24 is not going to be repealed or amended and to look for some other way to mitigate its effect – or simply to invest elsewhere.”

Maurice Patry FCA @LTSltd – Director, Landlords Tax Services Ltd (email: [email protected])

Founding Director of Less Tax 4 Landlords, Tony Gimple

“Google the term ‘Section 24’ and you’ll often find that landlords are generally being told to incorporate – i.e. move their property portfolio into a Limited Company.  The principal argument is that Limited Companies can deduct 100% of their finance costs.

But is that really the best way forward?

At Less Tax for Landlords we’re arguing that, rather than being a sensible move, incorporation is a one-way street and could end up being the most expensive ‘business’ decision you ever make.

Firstly, if you are incorporating an existing portfolio, you’ll want to make sure you qualify for Section 162 Incorporation Relief.  This is the transfer of ownership of all your ‘investment’ properties from your own name to your Limited Company, without having to pay Capital Gains Tax (CGT) or Stamp Duty (SDLT) in the process.

Until as recently as late 2017, should you have written to HMRC outlining your exact personal position, HMRC were giving non-statutory clearance for Section 162 applications. Obtaining clearance would mean that, unless you falsely represented your position, HMRC could not later come after you for a huge tax bill.

Now though HMRC will no longer pre-clear Section 162, and so you cannot guarantee that they will not force a very sizeable tax bill upon you when it’s too late to stop, and after you’ve already incurred all the other costs.

The other often overlooked danger with incorporation is with mortgages. Not only will you need to re-mortgage if the legal title changes hands (the law treats you and your company as being different ‘people’), but you will become a commercial borrower in the process as you are now borrowing money as a Limited Company. This means that all the consumer legislation protecting you goes out the window and the law now expects you to look after yourself. This is a very different world indeed.

Some Landlords have looked at using a Beneficial Interest Company Trust (BICT) to avoid the need to re-mortgage. However, read the small print and BICTs will likely constitute a breach of your mortgage terms and conditions. Not only that, should a lender call in your debt, other lenders may quickly follow suit, even if your account with them is in otherwise good order.

Likewise, any borrowing or bridging designed to create a director’s loan account needs to be genuine, with the borrowed monies physically ending up in your accounts, and not as part of an artificial ‘daisy chain’ where you never get to see the cash.

In summary, moving from being a private landlord to a corporate one will incur the following costs:

• Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) if you do not qualify for Section 162 Incorporation Relief;
• Early redemption charges;
• Mortgage brokers fees;
• Lenders fees;
• Legal fees;
• Losses that cannot be carried forward;
• Property will continue to form part of your estate for Inheritance Tax purposes.

Furthermore, whilst not in themselves direct transactional costs, being a commercial borrower impacts you in the following ways:

• There is a significantly reduced choice of lenders and higher interest pay rates;
• Lenders will mostly require full personal guarantees;
• Lenders will frequently restrict your ability to use your director’s loan account by way of a debenture;
• Each new acquisition or remortgage may need both a new lender and company if your existing lender isn’t interested;
• If property prices fall and the increased loan to value passes that which the lender originally agreed, you’ll have to find the cash difference;
• There are likely to be restrictions on what you can borrow (i.e. remortgage) to fund your lifestyle.

And of course, this does not take into account the value of your time.

Lastly, and the real sting in the tail, Limited Companies, and the individuals within them are taxed in up to seven different ways.  Genuine directors’ loan accounts to one side, there’s no way you can get your money out without paying even more tax than you are now.

Add this all up and does it work out better to incorporate than doing nothing at all?  For basic rate taxpayers with four or fewer BTLs, doing nothing is almost certainly the best play as Section 24 will have a minimal effect.

However, for those that are at risk of being pushed into a higher tax band and are therefore significantly exposed to the effects of Section 24, there are much tougher questions to ask.

For landlords with high loan to value ratios, reducing debt – perhaps funded by selling a property – might make sense.  Sadly though, you’ll almost certainly incur Capital Gains Tax in the process, and outside of a business structure, there is very little you can do about it.

That said, once you have crunched the numbers, for 95% of non-portfolio landlords (those with less than four mortgaged properties), doing nothing probably works out to be the best option – even if this does mean an increased tax bill.

In most instances, however, Less Tax for Landlords advises that, even if you are growing your portfolio, you to continue to buy in your own names – just make sure (like BTL mortgage lenders now have to do) you take into account the tax position before going ahead with the deal.

For those who are portfolio landlords AND already higher or advanced rate taxpayers, Section 24 could really mean ‘ouch time’.

We stress that landlords in this position may find that a combination of a Limited Liability Partnership and a Limited Company – also known as a Mixed Partnership or Hybrid Structure – might offer the best solution.  When properly arranged and managed, such hybrid tax property ownership delivers a recognised business arrangement that means:

• No need to remortgage or change title, thus no CGT or SDLT;
• Tax from your property income at the basic rate regardless of how much you draw;
• Seamless succession planning with Inheritance Tax typically mitigated within two years;
• Two layers of commercial limited liability and protection against family/marital breakup;
• Maximum commercial flexibility and choice of finance;
• Being fully in line with Government policy to professionalise the sector and compliant with both the letter and spirit of the law;
• Quick, easy and cheap to unwind if the rules change;
• More money in your pocket!

This isn’t appropriate for everyone of course, and the decision to move forward must be business-led, taking into account your plans for the future.

For example, if you plan to retire in a few years, then you might go from being a Higher Rate Taxpayer to a Basic Rate one overnight, making a business structure largely unnecessary.

If you are already, or you do plan on becoming a portfolio landlord in the near future, then Less Tax For Landlords have kindly offered a free initial assessment for my readers which you can access here.

Tony Gimple – Founding Director of Less Tax for Landlords (email: [email protected]) – Download the ‘Running Your Property Portfolio as a Business’ report

Founder and Managing Director of Kumar Strategic Consultants, Anil Mohanlal

“Towards the end of the last tax year (2016-17), we saw the first tranche of Section 24 of the Finance (No. 2) Act 2015 rolling out. Now we are into 2018/19 and 75% of mortgage interest costs will not be tax-deductible against gross rental receipts. Even though this has been known for quite some time, it’s quite extraordinary how a significant number of landlords remain unprepared. However, I do see that more are starting to realise that they need to do something despite the confusion about how Section 24 actually works in practice (often caused by a lack of good professional advice). There are, of course, some landlords who will not be affected at all so we’re seeing a real spectrum of individual scenarios – largely dependent on their existing holding structure and what tax threshold they find themselves in. Across Greater