Taxation of Income from Property
There have been radical changes to the taxation of property lettings over the past twenty or so years. Nigel Lawson in the 1980’s oversaw a complete overhaul of the legislation intended to encourage private landlords to invest in property in order to help resolve the housing issues at that time, radically changing the rules for taxation and introducing the legal concept of the six month assured tenancy agreement.
George Osbourne has different issues to address, chief of which is attempting to level the playing field between first time buyers and private landlords.
Furnished and Unfurnished Lettings for Individuals
In his recent mini budget he has removed higher rate tax relief on finance costs for private landlords to be phased in over four years from April 2017 the justification being tax relief on mortgage interest (MIRAS) was removed for homebuyers some years ago.
In addition he is removing the ten per cent wear and tear allowance for furnished lettings from April 2016 and although we are awaiting a consultation document we understand after that date landlords will be able to deduct the actual cost of replacing furnishings, fixtures and equipment rather than the current basis of the allowance based upon ten per cent of the rent.
Therefore for basic rate taxpayers owning a property for rental in their personal names there is very little change from their current tax position going forward.
He is also increasing Rent-a-Room Relief from £4,250 to £7,500 from April 2016 in the hope more people with spare rooms in their home are attracted by letting them out to further assist with current housing problems.
The Corporate Client.
In regard to the corporate investor they are unaffected by the above changes and will continue paying tax on profits at corporate tax rates and the removal of higher rate tax relief on finance costs is not relevant.
However they could be affected by the relatively new Annual Tax on Enveloped Dwellings (ATED) but this is dependent upon their portfolio of residential property.
The purchase of a residential property by a private limited company is attractive to those who have a corporate structure that has substantial reserves and/or they as individuals are higher rate taxpayers personally.
An individual higher rate taxpayer wanting to expand their property portfolio can accelerate that process in a limited company as profits from lettings would only be chargeable to corporation tax at 20% rather than paying 40% in higher rate income tax for a similar property owned outside the corporate environment.
Unfortunately, as is often the case, legislation can affect those to whom it was never intended. ATED was introduced to catch high net worth individuals, and consortiums utilising an offshore corporate tax structure to build portfolios of UK property, usually in the capital, and at the same time circumventing UK capital gains tax and corporation tax.
It is similar to some U.S. local governments collecting an annual tax charge based on the value of each residential property.
On introduction the initial charge was applied to properties worth over £2 million and as such not an issue for the vast majority. However that threshold has already been reduced to £1 million and it is set to reduce further to £500,000 over the next two years.
The further issue in regard to properties owned inside a limited company is that when sold the proceeds remain inside the limited company and a second tax charge arises on the shareholder if the company is closed and liquidated.
However from a retirement planning perspective this remains very tax efficient particularly as corporate tax rates are due to reduce to 19% in 2017 and 18% in 2020.
Furnished Holiday Lettings
For those with Furnished Holiday Lettings they are unaffected by the changes but the criteria is of course much restricted as to qualify as a holiday let. The Chancellor changed the rules some time ago in that the property must be available for rent for 30 weeks per annum and actually let for 15 weeks and losses can no longer be set against other taxable income in the tax year. This loss relief provision was particularly attractive for higher rate taxpayers to receive 40% saving on their holiday home costs and improvements.