With recent changes increasing the tax burden for landlords and property investors, is it time to rethink owning UK buy-to-let property?
With a raft of recent tax changes targeting landlords and property investors, is it time for expatriates to rethink owning buy-to-let homes in the UK?
Following a number of recent measures from the UK government, owning investment property now carries a heavier tax burden. With the average profitability of buy-to-let purchases estimated to fall 21% by 2020, it is unsurprising that one in five landlords are planning to reduce their property portfolio this year.
Increased council taxes, additional stamp duty and new capital gains tax liability for expatriates are just some of the changes that have negatively affected many property owners. Here we explore two key measures that can increase the tax burden for non-UK resident landlords.
Buy-to-let tax relief
Before April 2017, landlords renting out UK homes were able to discount 100% of finance costs when calculating their income tax bill. This included mortgage interest as well as loans for renovating property and buying fixtures and furniture. Depending on which tax band you fell into after adding rental income to your other income for the year, this effectively represented tax savings of 20%, 40% or 45%.
Last year, however, the UK government began phasing out this tax relief in the first step towards eliminating it entirely by 2020.
In the 2017/18 tax year, the deduction from property income was restricted to 75% of finance costs, plus a 20% tax credit. Another reduction in April 2018 means landlords can now only claim 50% of interest relief against the income.
Let’s say you earn £10,000 a year from buy-to-let property and pay mortgage interest of £5,000. Before April 2017, you could have offset all the interest and only paid tax on the £5,000 profit. For basic rate taxpayers this saved £1,000 in tax, higher rate taxpayers: £2,000, and £2,250 for those paying 45% income tax. But with today’s harsher rules in place, higher rate taxpayers can now only claim relief on £1,000 plus 20% as a tax credit – a tax saving of £1,500.
From April 2020 onwards, there will be no deduction at all; everyone receives just 20% of finance costs as a tax credit. In the above example, the maximum tax savings will be £1,000, regardless of your income tax band.
By this time, S&P Global Ratings estimate that 60% of buy-to-let purchases from 2014-2016 will become loss-making. For luckier landlords, this could still significantly affect returns and potentially push them into a higher tax bracket for their overall income.
See three common myths about investing in UK property
Owning property through a company
A tax-efficient approach in the past has been wrapping property in an ‘envelope’ – such as a corporate structure – instead of owning it directly.
However, since April 2016, an ‘annual tax on enveloped dwellings’ (ATED) of £3,500 to £220,000+ applies on indirectly-owned UK residential properties valued over £500,000. This significant drop from the previous two years’ thresholds of £1 million/£2 million brought many more property-owners into ATED range.
When sold or transferred, these properties also attract an ATED-related capital gains tax of 28% on gain accrued from April 2013. This overrides any other capital gains or corporation tax charge, so an indirectly-owned property will always be subject to the higher 28% rate (unless relief is available).
There are several other tax considerations with indirectly-owned property, including:
- Moving property in or out of an enveloped structure will trigger capital gains tax and stamp duty charges, including the additional 3% surcharge for second homes (in place since April 2016).
- Drawing income from a company-owned property is less straightforward than for individuals, and usually involves taking dividends. In April, the tax-free dividend allowance was trimmed from £5,000 to £2,000. Although rates remain at 7.5% to 38.1%, corporation tax also applies. While expatriates can potentially escape UK dividend taxes through the ‘disregarded income’ regime, this is not available for rental income.
- In April 2017, all UK residential property owned through certain offshore structures became liable for 40% UK inheritance taxes. For ‘excluded property’ trusts, this applies whether the property is owned directly or indirectly, occupied or let, and regardless of the domicile of the ultimate owner.
For many, this final measure stripped away the final tax advantage of owning property in this way. While the new ATED rules saw the Treasury collect 53% more taxes – £178 million – from homes owned by offshore companies in 2016/17, that dropped to £175 million in 2017/18 as property owners moved away from indirect structures.
Remember that expatriates now attract UK capital gains tax at 18% or 28% when selling any UK residential property. For non-UK residents, tax is only payable on gain accrued since April 2015 – so if you are thinking of selling your UK property, doing this sooner rather than later could reduce your tax bill.
See more about the tax costs of UK property
If you are concerned about the tax liabilities on your UK property, take personalised advice. An adviser with cross-border expertise can review how you hold your assets and identify opportunities in your country of residency that may offer much better tax advantages and returns than UK buy-to-let property.
Read ‘Look beyond property to unlock investment potential’
Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.