Clause 24 of the Finance Bill 2015 changes how Landlords are taxed.
The change in how the income from rentals is taxed as it is now added gross to other income.
In addition mortgage interest and other costs can only be off-set at the basic rate of tax.
These are the matters we are looking at today not the extra 3% Stamp Duty, general wear and tear allowance been withdrawn or PRA tighter minimum rent requirements on property affordability.
Tenants will presume that Landlords income has dropped by £X therefore they may expect there rents to rise by the same £x.
This is wrong the increased rent too has to go through the tax system.
To explain this, we will use Mr Leeds Average.
Who is Mr Leeds Average?
Mr Leeds Average is a model of the average landlord in the city of Leeds.
Average house price in Leeds is £185,536 (RightMove) and the average three bed rent being £899 (Leeds Market Rent Summary). Most landlords have a day job and the average Leeds income is £35,000 ( payscale).
If we make the presumption of a mortgage interest rate of 3.54% (a current 75% LTV Mortgage Works Tracker Product) the interest payments are £297 per month.
How much is Mr Leeds Average Taxed?
Mr Leeds Average would have net rental profit of £4,822 charging £899 rent per month in 2016.
Mr Leeds Average would have net rental profit of £4,505 charging £899 rent per month in 2020.
A small loss of £317 a year to the tax man (£26.40 per month)
As we know Yorkermen are prudent people and Mr Leeds Average wants to keep his net profit of £4,822.
Increasing rent by £317 a year (£26.40 per month) will do that? no.
Mr Leeds Average would have net rental profit of £4,692 charging £925 rent per month in 2020, still £130 less than 2016.
To get to the same net profit of £4,822 Mr Leeds Average has to increase rents to fill the £26.40 per month tax gap by £44.00 per month.
Mr Leeds Average would have net rental profit of £4,821 charging £943 rent per month in 2020.
Thats a basic rate tax payer! Its the Higher rate tax payers that are hurt most!
but you have to explain Mr Leeds Average first as a Basic Rate Tax Payer as government insists that only 1 in 5 landlords are effected.
This is wrong and it is more accurate to say that 100% of tenants are effected – which is why it is nicknamed “The Tenant Tax” rather than Clause 24 of the Finance Bill 2015.
How much is Mr Leeds Higher-Rate-Taxpayer Taxed?
If we increase Mr Leeds Average none buy to let income from £35,000 to £50,000 the results are a lot more shocking.
Mr Leeds Average would have net rental profit of £3,617 charging £899 rent per month in 2016.
Mr Leeds Average would have net rental profit of £2,905 charging £899 rent per month in 2020.
A loss of £712 a year to the tax man (£59.33 per month)
As we know Higher Rate Taxpayers are prudent people and Mr Leeds Higher-Rate-Taxpayer wants to keep his net rental profit of £3,617.
Increasing rent by £712 a year (£59.33 per month) will do that? no.
Mr Leeds Average would have net rental profit of £3,332 charging £938 rent per month in 2020, still £285 less than 2016.
To get to the same net profit of £3,617 Mr Leeds Higher-Rate-Taxpayer has to increase rents to fill the £59.33 per month tax gap by £99.00 per month.
Mr Leeds Average would have net rental profit of £3,617 charging £998 rent per month in 2020.
Will Landlords raise rents?
Yes – if the market allows then Landlords will look to retain profits.
This depends on the market, not all areas will allow landlords to raise rents. That may change with construction at low levels and an increasing population add in the presumption that less landlords will enter the market and some may sell. The already high demand for rental accommodation may allow rents to rise.
In a survey the Residential Landlords Association found that 84% of private sector landlords are likely to consider increasing rents.
What Tax Planning can be done?
Mortgage Statistics have shown a large switch from landlords buying in personal name to buying in a Limited Company.
Companies maintain mortgage interest releif and can reduce personal tax liability with retained profits.
Moving properties from personal name to limited company, is not so simple either. To do it today would involve a sale and purchase, resulting in tax liabilities of SDLT and Capital Gains.
Accounts are advising a path of incorporating a persons property portfolio into a limited company first via a LLP but it takes a few years and requirements set by HMRC may prevent some.
Limited Company buy to let may not be the most tax efficient Mr Leeds Average had to pay an extra £317 a year to the tax man – paying an accountant to file company accounts may cost that, regardless other tax factors. It is wise to take professional advice from a tax advisor and your mortgage broker. If you are looking at a portfolio or are a higher rate taxpayer then a limited company makes a lot more sense.
Want to download the calculator used in these test? Download the Tax Calculator.