Understanding what you need to do to protect your investment income.
The Nationwide Building Society has calculated that a property investor who pays higher rate tax, with a £150,000 buy-to-let mortgage and monthly rental income of £800 would have a net profit of £2,160 prior to the tax change. By 2020, this net profit would fall to just £960.
There are a number of strategies that can be employed to reduce the effects of this major tax change. Of course, you should always ensure that you:
- Conduct your investment research and due diligence properly to ensure the area in which you’re investing is investible
- Buy an ‘every person’ house to ensure that your property attracts the best tenants at the highest rent
- Design a strategy for your investment property cash flow taking into account the tax changes
- Ensure that you factor in a cushion for possible interest rate rises (Mortgage Cost Averaging)
But what if you have an existing investment property or portfolio of properties? Here are four strategies, each of which has merit:
1. Review your mortgage/s
This is a tactic that you should be using on a regular basis. The mortgage market is continually changing, and lenders respond to competitive pressures, regulatory issues, and changes in the Bank of England base rate. Switching to a shorter-term fixed rate deal could shave the interest you pay, though you will increase the risk that when you need to change at the end of the fixed rate the new interest rate offered may be higher.
2. Transfer your property to your spouse
If you are a higher rate tax payer and your spouse pays tax at a lower rate, then you could transfer one or more properties into his or her name. However, you’ll need to be careful with your maths to ensure that the extra income doesn’t take your spouse into the higher rate tax bracket.
3. Form a limited company for your property
Instead of holding your property in your own name, you could create a limited company for your investment properties. The upside is that you’ll only pay corporation tax on the profits, which is far lower than higher rate income tax, and you’ll be able to offset the mortgage interest.
If you want to access the profits, you can take them as dividends – and from April 6th 2016, you’re allowed to take up to £5,000 of dividends tax free (above this amount, basic rate taxpayers will pay 7.5% tax on dividends received and higher rate taxpayers will pay 32.5% tax).
However, there could be problems with choosing this route:
- For example, the transfer would count as a disposal and create a CGT liability
- The company would need to pay stamp duty on the ‘purchase’
- You will need to file annual returns and have an accountant draw up the annual accounts
One final drawback of transferring into a limited company is the Annual Tax on Enveloped Dwellings (or ATED), and from April 2016 this will be charged at a rate of £3,500 on homes worth more than £500,000 and rises to more than £200,000 on a home valued at £20 million.
4. Raise the rent you charge
If your tax liability explodes, then you may feel forced to raise the rent that you charge your tenants. However, dependent upon market conditions and the rental market in the area of your investment property, this may not be possible. This said, it is certainly worth ensuring that as part of your continuous investment strategy you regularly review achievable rents for properties like yours.
UK Property Tax ebook
In my latest book, UK Property Tax, we explore the most current tax issues after UK Budget 2016 that are important to property investors.
Most importantly, we’re going to examine the changes that will affect buy-to-let investors through 2016 and beyond and get to the bottom of how they will affect you as a property investor. Finally, we’ll let you in on how you can minimize the tax you’ll need to pay under the new tax rules.
Download the free copy of the book by clicking the download button below…
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