The Non-Accountant's Guide To UK Property Tax - Part 2

Following on from my post last week, (Thanks for your comments!) I wanted to help out a little more... covering capital gains tax, stamp duty and mortgage interest relief... fascinating stuff hey? I've also included a calculator for you if you missed my last post. Feel free to leave comments, like & share... 

Calculating Your Capital Gains Tax Liability

Capital Gains Tax (CGT) CGT is payable when you dispose of an asset and make a profit on it. Most commonly we think of disposal as being the sale of the asset, but disposal also includes:
? Gifting it
? Transferring it to someone else
? Exchanging it for something else
? Being paid on an insurance claim if it has been destroyed
(It’s worth noting here that if you transfer your investment property to your spouse, then the disposal is assumed to have taken place at the original cost and so no CGT will be payable until your spouse sells the property.)

While your main residence will escape CGT liability, investment properties will incur CGT. In order to calculate your CGT liability, first work out what the gross capital gain is by simply deducting the original purchase price from the sale price. 

Now comes the bit where you reduce the gain. You are allowed to deduct all of the following from the gross capital gain:
? Valuations and solicitors fees
? Estate agent fees and marketing costs
? The cost of any improvements made (not maintenance and repair costs)
? Stamp duty and VAT

This will leave you with a net amount on which CGT will be liable. However, the amount that you have to pay will further depend on your gross income (CGT is payable at the rate of either 18% or 28%) and your use of your CGT allowance (in 2016/17, for example, you are allowed to make a total capital gain of ￡11,100
before incurring a CGT liability). 

Don’t confuse the rate you will pay on a residential property with the usual rate, there is effectively an 8% surcharge bringing the CGT up to 18% or 28%. Thank Evil George for that. Finally, you may also be able to take into account one of the
following reliefs if it applies to you:
? Entrepreneur’s relief (if the property sold is a business asset)
? Gift hold over relief (if you are gifting a business asset)
? Business asset roll-over relief (to defer tax if you are reinvesting the proceeds of the property sale into another business asset)

My recommendation here is always, always get good advice.
Speak to a financial advisor and a tax specialist before you sell the property and assess your tax position fully. I’ve known investors who have simply sold at the wrong time of the year and incurred a huge tax bill because they didn’t ask for advice first. Even delaying a sale by two or three weeks around the end of the
fiscal year could save you thousands in unnecessary taxes.

A Simple Strategy To Consider

If you are planning on selling more than one property, sell one in the tax year previous to April and the other in the following. So March and April you can sell two properties and claim the Capital Gains Allowance in both years. You will also benefit from selling at the time of the spring bounce in prices as the weather heats up and people go out to find their next property.

The Tax Rules are Changing
And so with Evil George low on money, and borrowing billions to fund his long liquid lunches, and over the top banquets he turned to landlords to pick up the bill. He did something no one had ever done. He taxed the people on their expenses! People were afraid! How far would he go in his plan to cripple the hard working people in favour of his big corporate henchmen. 

New Rules For Wear And Tear

Before April 2016, if a buy-to-let landlord leased a property to a tenant as fully furnished the landlord could claim an amount against rental income as wear and tear. This was set at 10% of the rent received. After April 2016, all landlords will be able to deduct the actual costs of replacing furniture. So the good news is that this deductibility of costs has been extended to include landlords of unfurnished and partly furnished homes. The bad news is that deduction is no longer automatic and that claims are limited to replacement of items that are provided for the use of the tenant. Such items include:
? Movable furnishings such as beds and sofas
? Televisions
? White goods
? Carpets, curtains, and linen
? Crockery and cutlery
Items that would normally be sold as being integral to the home (e.g. baths, sinks, boilers, toilets) are not included.
Further, deductions can only be made upon provision of receipts that detail the cost of the replacement made.

New Stamp Duty Charges

Stamp duty that is payable on the purchase of a property is being increased for
buy-to-let investors. Of course, when it comes to selling the investment property
the stamp duty paid can be deducted from the gross capital gain (as we saw earlier) but this still represents a substantial increase in the initial outlay for an investor.

The Chancellor of the Exchequer (aka Evil George) has called this new charge
the ‘stamp duty surcharge’. It is set at 3% for all investment properties, though
properties under ￡40,000 will remain exempt from stamp duty. But find me a
property worth investing in under ￡40,000. The easiest way to see this in action is to look at it in a tabulated form:

Example 1: John buys a ￡185,000 property. Stamp Duty: ￡6,750
Example 2: Cindy buys a ￡325,000 property. Stamp Duty: ￡16,000
Example 3: Rob & Natalie buy a ￡550,000 property Stamp Duty: ￡34,000

I've created a calculator for stamp duty. Have a play!

Mortgage Interest Tax Relief – Elephant In The Room?

Prior to April 2017, a buy-to-let investor can claim all the mortgage interest that they paid against the rental income produced by their property. This was a big positive for all property investors, but especially for those that pay a higher rate of tax.  For example, let’s say a higher rate tax payer owns an investment property on which the rental income is ￡1,000 per month and mortgage interest payments are ￡600 per month. Over the course of the year, the investor would make a net ￡4,800 in rental income.
(For ease of calculation, and to show the impact of the changes being made, we’re not including any of the other deductions that an investor
could claim.)
The tax that the higher rate investor would be liable to pay is ￡1,920.
The investor’s net gain after tax is ￡2,880.

A basic rate tax payer in the same scenario would pay ￡960 in tax and have a net
gain after tax of ￡3,840.

How Mortgage Interest Tax Relief Is Changing

From April 2017, the way in which tax relief on mortgage interest is calculated is
going to change. Up until now you have been able to offset your mortgage interest, as an allowable expense, against the income you earn on the property. In fact, most accounting standards and countries around the world adhere to this simple premise. As a property investor, you’ll now owe tax on the entire rental income less the allowable expenses. You’ll still be able to claim tax relief on your mortgage interest, but the rate at which that relief is given will be gradually reduced until it is given at 20% (the basic rate of income tax) in 2020/21.

Instead of deducting the mortgage interest paid from the rental income, you’ll
have two calculations to make:
? Calculate your tax on the gross rental income (after tax allowable deductions
have been made)
? Calculate the tax relief on the mortgage interest at the basic rate of tax

So, let’s see what difference this change makes to our two investors above:
Example - Assume the Investor has a property whose Net Rent is ￡1000 per month and mortgage payments are ￡600 per month on a ￡240,000 mortgage owing. 

The basic rate tax payer:
? Tax on gross rental income = 20% x ￡12,000 = ￡2,400
? Tax relief on mortgage interest = 20% x ￡7,200 = ￡1,440
? Tax under old scheme = ￡960
? Tax under new scheme = ￡960
? Difference is zero
One point is to be careful as the non deduction of the mortgage interest may tip you over the basic rate into the additional rate of tax. 

The higher rate tax payer:
? Tax on gross rental income = 40% x ￡12,000 = ￡4,800
? Tax relief on mortgage interest = 20% x ￡7,200 = ￡1,440
? Tax under old scheme = ￡960
? Tax under new scheme = ￡3360
? Difference is ￡2400 per year or ￡200 per month.

As you can see, if you’re a higher rate tax payer and have invested with the help of a mortgage, the effect of this tax change is that your tax bill will go up by ￡2,400 per year. That’s just the start because the question is where do you find that extra money from? Now for the real kicker… 

What happens if interest rates rise?
Let’s stick with the same example, and imagine that both property investors
are currently paying mortgage interest at 3% on their buy-to-let mortgages. Now
let’s imagine that the Bank of England raises the base rate, and lenders respond by raising rates on their buy-to-let mortgages to 4.5%. Look at what happens to the positions of the two property investors in our example:

The basic rate tax payer:
? Tax on gross rental income = 20% x ￡12,000 = ￡2,400
? Tax relief on mortgage interest =
20% x (￡240,000 * 4.5%) ￡10,800 = ￡2,160
? Tax under old scheme = ￡960
? Tax under new scheme = ￡960
? Notice the tax stays the same as interest rates rise and fall.
? The difference is that you are now paying an extra (￡10,800 - ￡7,200)
￡3,600 per year or ￡300 per month.

The higher rate tax payer:
? Tax on gross rental income = 40% x ￡12,000 = ￡4,800
? Tax relief on mortgage interest = 20% x ￡10,800 = ￡2,160
? Tax under old scheme = ￡960
? Tax under new scheme = ￡3,360
? Difference due to additional Interest payments ￡3,600 +
Additional Tax ￡2400 = ￡6,000 per year.
? In addition, the property is now making a cash flow loss each year of ￡1,440.

So you are paying tax even though you are making a loss. That’s a full ￡6000 per year you have to find. Stolen from you by Evil George. As you can see, the higher rate tax payer is now making a loss because of the changes in the way that mortgage interest relief is calculated and the increase in the mortgage interest rate. I cannot stress enough how important it is to be aware of this effect. Plan now for this change, because you still have time to take action that will ensure your property portfolio remains profitable, and if not profitable at least viable.

10 Property Investor Client Case Studies

So let’s face it, tax is boring, so boring I added a bit of a fairy tale throughout my Free Book The Non-Accountant's Guide To UK Property Tax. The information in my book is hard to really understand and personalise.  That’s why I have included real life client case studies without knowing your circumstances. I have changed their names but all the details are real except where they couldn’t tell me and it was going to be too much trouble to calculate it.  Regardless the few bits of information, usually costs associated, wouldn’t have changed the outcome. Also some of the reviews were undertaken from 2013 onwards so the figures may have changed since then, but let's not get caught up in the accuracy and more importantly look for the patterns for type of portfolio you have.

So, I looked at 100 client portfolios, available as part of my tax calculator, and I tried to include as big a spread of portfolios as possible. 

Why is it important to personalise the changes to your portfolio?
I spoke to one accountant who whilst not really knowing me or my situation, and
clearly not having Googled my name, immediately went into a sales pitch for moving the portfolio into a company structure at the same time re-mortgaging and taking capital out to put into his latest investment scam…. It probably wasn’t a scam but the investment had ‘his commission’ written all over it.

Meanwhile I would have paid well over ￡100,000 in stamp duty to make the move. Money down the drain, never to see the light of day again. Let's look at the variables to consider that are impacted by the tax changes.

Earned Income (aka your job or business)
Prior to the changes your earned income through your job or business was
considered separate to your investment income. With the new changes your rental less costs plus your earned income will be added to produce your
total income, which is what your tax will be worked out on. So obviously if you earn less than ￡11,000 then you won’t be taxed, less than ￡32,000 you will remain a basic rate tax payer and be allowed to offset this at the basic rate. If this takes you over the basic rate then you will pay higher rate tax and if you
are already a higher or additional rate tax payer then you will be limited to basic rate of relief or mortgage interest.
Mortgage Repayments
The higher the repayments the greater the affect on cashflow and therefore the more impact the changes are going to have on your portfolio. This is perhaps the biggest factor affected by the changes.
Size of Debt
The size of the debt you have will have a greater effect as interest
rates rise. This in my prediction could be the real kick in the teeth
to investors even though it has nothing to do with the current
changes.
Rent Received
The rent you receive for your portfolio will determine how much
the changes affect your cash flow through firstly the tax you pay
and secondly, through the cash flow your portfolio generates for
you. Both these need to be considered.

Whilst there is nothing you can do about the tax side except claim all of your allowances to the maximum and not being lax with your record keeping. We can do something about the cash flow side, namely restructure our portfolio over the next 4 years to accommodate the changes.

My Tax Calculator helps you work out where you stand and will help you prepare your portfolio for the changes that lie ahead.

The 5 Questions I ask on my Tax Calculator in looking at over 100 individual portfolios from our clients are:
1. Annual Earnt Income
2. Annual Gross Rent
3. Annual Allowable Costs (or 15% where they didn’t know)
4. Annual Mortgage Costs (excluding Principle payments) (or 3.5% of total debt owing where they didn’t know)
5. Total Mortgage Debt Owing.

With this information I was able to calculate the changes and create 10 Case Studies (there's a further 90 others in the spreadsheet). These are available in my Free Book The Non-Accountant's Guide To UK Property Tax

Sir Jon Cunliffe, a deputy governor at the Bank of England warned that the rise in property ownership by private landlords threatens the stability of the UK economy. His major concern is that an army of buy-to-let investors will sell en-masse in reaction to tax changes or rising interest rates that crush landlord profits. If this happens, he predicts a “spiral of house declines”.

Today, one in five of all mortgages is a buy-to-let mortgage
Approaching 25% of all homes are buy-to-let properties

The problem is that selling en-masse never happens, look at the last recession, the worst in 100 years, no one sold en-masse. In fact, most people kept their properties and suffered through a decade of low house price growth. In fact, in 2016 as I write this many places have still to see any growth in prices. 

So will you restructure your residential property investment portfolio? Will your cash flow be positive, neutral or negative? How will you incorporate new build and off plan residential property into your investment portfolio going forward? 

Live with Passion and Fun,
Brett

Brett Alegre-Wood. Property Expert, Educator and Entrepreneur
Follow @brettalegrewood + @ypcgroup