HMRC is reducing tax relief on interest you pay on loans used to buy properties to let. What is the issue and how can you minimise the impact?
The issue – interest tax relief recap
Until 5 April 2017 interest paid on loans to buy a residential buy-to-let was fully tax deductible. Since then, for individuals and partnerships it has only been partly deductible, and from 6 April 2020 not at all.
Instead, partial relief, equal to the basic rate of tax 20%, is allowed as a credit against the tax payable on the rental income. The restriction applies not only to interest to buy a property but other finance costs, e.g. loan/mortgage arrangement fees. It also applies to interest etc. paid on loans to improve residential let properties or buy furnishings for them.
The interest restriction can be completely avoided by transferring the let property to an existing or new company (although another restriction applies if its profits exceed £2 million). A second advantage is that companies pay corporation tax at 19% (17% from 1 April 2020) instead of income tax at up to 45%.
But there are downsides including:
(a) having been subject to stamp duty land tax (SDLT) when you bought the property it may apply again when you transfer property
(b) if the property has increased in value since you acquired it there might be capital gains tax (CGT) to pay at 18% or 28%
(c) having incurred legal costs when you bought the property there will be further legal costs for the transfer
(d) you’ll have to pay personal tax when you take the rental income from the company, which could outweigh the tax saving made by avoiding the interest restriction
Joint personal ownership
If you have a spouse or civil partner who pays tax at a lower rate than you, there’s a less problematic way to minimise or avoid the interest relief restriction. If your taxable income means you pay tax at, say, 40% while your spouse or partner pays at 20%, transferring all or part ownership of the property to them reduces the tax bill .
Tips and benefits:
(1) Unlike the transfer to a company, there’s no CGT to pay where the transfer is to a spouse or civil partner
(2) If the transfer is made as a gift, SDLT etc. will only be payable if your spouse etc. doesn’t take on a corresponding share of the mortgage
(3) You can transfer 50% of the income for tax purposes, and so gain the tax advantages mentioned above, by transferring far less, say, 5% of the property to your spouse etc.
As always with tax planning, careful consideration is needed based on individual circumstances, so talk to your tax advisor first!