Irrespective of the position on the tax banding scale, all landlords should be aware of the risks and repercussions resulting from Section 24.
Firstly, as interest rates have increased, some landlords struggle to re-mortgage to competitive pay rates. Others remain stuck on high Standard Variable Rates (SVRs).
Secondly, Section 24 has meant higher tax bills and poor (or even negative) cash flow. The situation becomes worse for those who have taken out a high level of secured debt (“overgearing”).
In the examples below, Landlord A and Landlord B are personal owners of properties with market values of £100,000. The gross yields generated from both properties are 7.2% – i.e. £600 per calendar month in rent.
It is important not to panic. Many landlords have successfully dealt with the repercussions of this legislation.
As a priority, we strongly suggest discussing your position with a suitably qualified accountant or tax advisor. This also goes for any future buy-to-let purchases you plan to make.
In addition to the calculator above, your accountant will be able to provide spreadsheets and tools to help project future tax liabilities in good time (using previous tax returns, for example).
There are also a number of potential strategies worth considering…
The regulatory / compliance requirements and prevailing anti-landlord sentiment can make the sector offputting. For this reason, many property investors have exited the sector.
Others have made capital repayments or transferred lump sums from existing savings towards the overall mortgage amount. The aim here is to reduce the overall level of gearing.
In this scenario, remember to check with your lender that you will not incur any Early Repayment Charges (ERCs) for the overpayment(s).
Disposing of the property/properties and then using the outstanding sales proceeds to make further acquisitions within a more tax-efficient Limited Company structure can work well.
Remember to take into account any potential Capital Gains Tax (CGT) liabilities and check for any allowances that you may be entitled to. You will also incur higher rate stamp duty in England and Wales (check the calculations in Wales and Scotland) when buying new properties alongside conveyancing fees and other transactional costs.
Bear in mind the ongoing tenancy and other cash-flow / management issues as you manage the process. A good accountant can also advise you on how to be tax efficient.
Providing he/she is a low-rate taxpayer, transferring ownership of the property to your spouse or civil partner is sometimes a workable solution.
However, it is important to confirm that any supplementary rental income will not push him/her into a higher tax bracket.
This strategy may also backfire in the future should your spouse / partner wish to gain extra income through employment or other means.
This will largely be dependent on local market dynamics. Landlords need to be certain that price rises directly correlate to the quality of housing provided and overall affordability levels.Particularly outside of London and the larger cities, wages are not rising as sustainably as many are led to believe. Certain cross-sections of tenants also may not be able to claim sufficient levels of housing benefit (Local Housing Allowance). Many also continue to struggle to keep up with bills and other household costs which, in turn, is causing voids.
Furthermore, investment property owners should also be mindful of fuelling the already tense “anti-landlord” sentiment across the UK.
Remember that refurbishment costs are still 100% tax deductible. Investing any capital you have to improve the condition of the property can help offset the effects of Section 24.
It may also be possible to use occupational pension contributions to reduce net employment income.
Perhaps the most debated strategy to mitigate Section 24 is to effectively “sell” personally owned properties into special purpose vehicle (limited company) structures. Accountants refer to this process as incorporation.
However, before proceeding, we would strongly recommend a cost-benefit analysis alongside careful tax planning with a suitably qualified professional.
Also, note the following facts:
It’s possible to eliminate Capital Gains Tax (CGT) by means of a qualifying business transfer in exchange for shares. Accountants and tax advisors often will refer to this as incorporation relief.
In this scenario, the following needs to be demonstrated:
This latter point, unfortunately, is likely to be an unsubstantiated argument for most small, medium and even larger sole-trader landlords to make.
Each case will be judged on its own merits, however, the most common legal precedent cited at the time of writing is the “Ramsay” case (Elizabeth Moyne Ramsay v HMRC [2013]), where the plaintiff2 was able to demonstrate 20 hours of working in the business for the purposes of s.162 of the 1992 Taxation of Chargeable Gains Act (TCGA).
In short, the court decision was based on a qualitative analysis of “hands-on” involvement in day-to-day management3. Activities such as attending courses, networking and property viewings would usually be acceptable justifications.
2 Mrs Elisabeth Moyne Ramsay who had a single property divided into 10 self-contained apartments with a large communal area, car parking, garages and a garden. [Back to Content]
3 Spending at least 20 hours a week on property activity, Mrs Ramsay and her husband (both of who did not have any other occupation) engaged in the following activities:
[Back to Content]
When transferring a portfolio of properties into a Limited company – to mitigate Stamp Duty Land Tax (SDLT) – it may be possible to benefit from multiple dwellings relief.
Here, the level of tax is based on the average value of all the properties being transferred into the Limited company in exchange for shares.
As an example, if an investor has a residential portfolio of 15 properties valued at £2.1 million – each with an average value of £140,000 – the amount of SDLT owed per property would be £4,500 (£125,000 at 3% in addition to £15,000 at 5%), giving a total of £67,500.
Another option could be for the Limited company to opt for the transfer to be taxed at non-residential rates when six or more properties are transferred at the same time. In this scenario, the additional 3% residential investment SDLT surcharge would be exempt.
However, it should be noted multiple dwellings relief would not be available and Stamp Duty would be applied to the total value of the entire portfolio.
In most situations, therefore, property given away or transferred to another person or limited company will involve “chargeable consideration”. This effectively means that Stamp Duty is by and large unavoidable.
By virtue of Schedule 15 of the 1890 Partnership Act, it’s possible to move properties into a partnership for a period of between 2 and 3 years (prior to setting up a Limited Company).
In a similar vein to incorporation relief, there must be two “connected” people working together in a genuinely commercial business environment.
Note that whilst spouses, siblings, civil partners, parents and their adult children theoretically count as two partners, the use of this exemption has become open to some debate.
HMRC can remove the relief should it be deemed that the partnership creation is deliberately for the purpose of avoiding SDLT.
However, assuming that the partnership is legitimate in the eyes of the tax authorities and not contrary to any anti-avoidance legislation, the following steps would need to be taken:
You may discover that following the above steps to reduce CGT and SDLT has actually not saved any costs
Note also that extracting profits from a Limited Company is more difficult. There will also be chargeable income tax on dividends (on any amount over £1,000) which may also lead to a greater effective personal tax burden if you are a higher (or additional rate) taxpayer.
Should the money be withdrawn as a salary, National Insurance will also be levied. There will be corporation tax on profits made from rental income and future disposals.
Avoid Deed of Trust arrangements (also known as Beneficial Interest Company Trusts). The core idea of using an artificial structure to transfer the beneficial interest of a property into a Limited Company. The theory is that the landlord can then retain title and keep the mortgage in one’s own name (as a nominee).
The wide consensus amongst tax advisors is to avoid such schemes. Indeed, breaching tax laws can often lead to unexpected liabilities and even serious financial penalties down the line.
The principal issue from a tax perspective is a section of the Income Tax Act that prevents individuals from transferring an income stream into a company for tax reasons. Most (if not all) lenders terms and conditions also disallow for mortgage transfers into a company in this way. In the best-case scenario, the mortgage company may re-issue the loan in the company’s name but under entirely different terms.
Moreover, borrowers may well be open to allegations of “mortgage fraud”. In worst-case scenarios, this could lead to a demand for immediate loan redemption, penalties or even more serious legal action.
Much of the content in this post merely scratches the surface. To reiterate, Property Solvers Auctions are not accountants or tax advisors. We strongly advise having any decision reviewed in detail by a qualified professional.
In this regard, it should be noted that many accountants are not fully versed in the area. Specific due diligence of the firm is theefore strongly advisable. As well as Companies House, the necessary credentials can also be verified at the Institute of Chartered Accountants in England and Wales and the Chartered Institute of Taxation.
It is also possible to obtain a “pre-transaction ruling” or a “non-statutory clearance” (in writing) from the HMRC. This will more certainty that there are no contraventions of General Anti-Abuse Rules (GAAR), Disclosure of Tax Avoidance Schemes (DOTAS) or other tax evasion legislation.