Twist or Stick? Is it still tax efficient to hold residential buy-to-lets?

Aug
27
Posted 2019 by Chris Davies

For many years, residential buy-to-lets were seen as a very tax efficient investment opportunity and we were regularly approached by new clients anxious to get in on the act for tax advice. Potentially low rates of capital gains tax on sale along with some very generous exemptions and potentially full tax relief on the mortgage interest that was unavailable on principal private residences made these investments very attractive

But over recent years successive Chancellors have whittled away at the advantages, with the next changes due in 2020.

As a recap, capital gains tax rates on residential properties were raised to 18% and 28% respectively from April 2017 compared to tax rates of 10% and 20% respectively for gains on other assets.

Full tax relief on mortgage interest is being phased out over a number of years and from April 2020 taxpayers will no longer be able to claim a tax deduction for any mortgage but will instead be given a tax credit of 20% of interest paid.  For many basic rate taxpayers this will have no effect but for higher or additional rate taxpayers what that effectively means is that they will pay tax at 40% or 45% on the income minus expenses, but only get tax relief for the interest at 20%. For many that could put a previously profitable rental stream into a negative position.

For example imagine a higher rate taxpayer with rental property producing an income of £10,000, expenses of £3,000 and mortgage interest of £6,000. 

Previously the position would have been:

£
Income10000
Expenses(3000)
Mortgage interest(6000)
Profit1000
Tax due at 40%(400)
After tax profit600

From April 2020 the position is :

£
Income10000
Expenses(3000)
Mortgage interest(6000)
Profit1000
Tax due at 40% on (£10,000-£3,000)(2800)
Tax relief on mortgage interest 20% x £6,0001200
After tax loss(600)

As a basic rule where there are chargeable and non-chargeable periods the gain is time apportioned.

Currently where a buy to let is sold and the taxpayer at some point lived in the property as his principal private residence, the last 18 months of gain are automatically deemed as a period of occupation by the taxpayer.

Furthermore, having calculated the gain there is a Lettings relief which exempts each taxpayer (ie two allowances are available in the case of jointly held property) the lower of:

  1. The gain attributable to the letting period
  2. £40,000
  3. Principal Private Residence relief

From April 2020 it is proposed in the Finance Bill that the exempt period be reduced from 18 months to 9 months and the potential lettings relief will only apply to properties that are in shared occupation with a tenant ie houseowner and lodger with shared facilities situations.

That could have a huge impact of the tax payable on the sale of a property. For example consider husband and wife who are both higher rate tax payers selling a property that they have both lived in and let out as follows:

Total period of ownership 132 months May 2008 to April 2019                   

Period of their occupation  72 months May 2008 to April 2014

£
Disposal proceeds
500000
Original cost
(200000)
300000
Less: PPR (including final 18 months) 90/132 x 300000
(204545)
95455
Less lettings relief lower of:
- Gain attributable to letting period 60/132 x 300000 = £136,363
- £40,000 each = £80000

- PPR relief = £204545
(80000)

15455
Less:Annual exemption restricted to gain
(15455)
Taxable
0

But what if they defer the sale by 12 months to April 2020? The position then becomes:

Total period of ownership 144 months May 2008 to April 2020                   

Period of their occupation  72 months May 2008 to April 2014

    

£
Disposal proceeds
500000
Original cost
(200000)
300000
Less: PPR (including final 9 months) 81/144 x 300000
(168750)
131250
No lettings relief as no shared tenancy
Less:Annual exemptions 2 x £12500(25000)
Taxable106250
Tax payable at 28%29750
                                                                                                                                                 £

That is a significant increase in tax payable and may well incentivise those in a similar position of thinking of selling to do so before 5 April 2020.

Finally, there is one major administrative change coming into force from April 2020. Although this will not affect the overall tax payable it will significantly affect the timing of payment.

From April 2020, any tax payable by a UK resident taxpayer as the result of the sale of a residential property must be reported to HMRC and paid within 30 days of completion.  That is a very tight timescale and we know from experience that rarely will taxpayers have immediate access to all records such as completion statements for the purchase some 20 years ago, dates of lettings, records of capital expenditure etc.

It is easy to see how this requirement will be missed by many taxpayers and their conveyancers/advisors who will not be aware or do not understand fully the new rules leading to significant penalties and dare I say it, professional indemnity claims against those advisors

Mercifully no returns will be required for disposals were no tax is due 

Buy-to-lets have certainly taken a hammering in recent years and that’s without even mentioning the changes to Stamp Duty Land Tax which are the subject of further blogs on our website.

If you have any questions on these matters or your tax affairs generally please do get in touch either through the Contact Us form or by calling your local Ross Brooke office.