As a private landlord there are many expenses you can claim against your rental income to reduce your tax liability, examples being agents’ fees, legal fees, accountants’ fees and insurance.
Loan interest and, for furnished residential lettings, a “wear and tear allowance” for furniture and equipment you provide are also deductible expenses and it is these that are changing as a result of the Summer 2015 Budget. This may ultimately increase the tax you are paying as a landlord.
Currently you can claim 10% of the net rent “wear and tear allowance” – net rent being rent received less any costs you pay that would usually be paid by the tenant, e.g. Council Tax. This is claimed instead of claiming the cost of any replacement furniture and equipment and is in additional to any repair costs. It can be claimed irrespective of where expenditure is incurred or not.
It is proposed that the wear and tear allowance be withdrawn from 6 April 2016, to be replaced by a new relief that will allow all residential landlords to deduct the actual costs of replacing furnishings etc. This is currently subject to consultation. The new relief is likely enable a tax deductible expense to be claimed for replacement “furniture, furnishings, appliances and kitchenware provided for the tenant’s use” and, as at present, is unlikely include the initial cost of furnishing a property.
Depending on how frequently furniture and equipment is replaced you may see a reduction in relief and thus an increase in tax payable. To mitigate this, where possible it is recommended that you avoid replacing any such items until after 6 April 2016, thus retaining the wear and tear allowance in the current tax year and also getting a deduction for the replacement cost in the next tax year.
Currently all landlords can claim interest relief for any loans or financing directly related to their rental income – this includes mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans. This interest relief is claimed as an expense against income, in line with other property expenses, in calculating the profit to be taxed, with any losses carried forward against future property profit.
From 6 April 2017 this relief will be restricted, on a staged basis increasing by 25% each year. By 6 April 2020 no relief will be available but it will be replaced with a tax reducer at the basic rate.
Basic rate tax payers will not be financially impacted by these changes, it will only impact on how their self-assessment tax returns are compiled. However, those paying tax at the higher and additional tax rates will have an increased tax liability with their relief effectively restricted to that of a basic rate tax payer.
There is every chance that properties that were generating a net income could become loss making, depending on how the property is geared. Whilst this measure is being promoted by HMRC as being “to make the tax system fairer” it will be interesting to see the impact it may have on the housing and rental markets. Landlords may sell off less profitable properties or try to increase the rental levels to recoup the additional tax being paid.
To mitigate the withdrawal of the wear and tear allowance it is recommended that where possible you defer replacing any qualifying furniture and equipment until after 6 April 2016. You will then retain the wear and tear allowance in the current tax year and also get a tax deductible expense for the replacement cost in the next tax year.
If you are going to be caught by the interest relief restrictions in, beyond the changes in presentation within your returns, we recommend you review now the impact this will have on your property portfolio, the tax exposure and your cash generation. It may be that you consider selling or refinancing ahead of the interest relief changes. We can help you determine the financial impact, provide financing advice and also consider any capital gains tax implications if you do decide to sell.
If you don’t already declare your rental income you should be aware that HMRC is currently targeting residential landlords. They are inviting landlords to make a voluntary declaration through their Let Property Campaign.
If you need any assistance with your current position or guidance on how the changes will impact you then get in touch straight away and we will be happy to help.