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TDQ: AF1, R03 and private landlord taxation

10 June 2019

Catriona Standingford, MD of Brand Financial Training examines the personal tax issues for private landlords, a topic that is most likely to arise within the CII’s AF1 and R03 exams

When studying for the CII’s R03 Personal Taxation or AF1 Personal Tax and Trust Planning exams, the first topic that springs to mind probably won’t be in relation to private landlords. However, there have been various changes made in recent years for private landlords and candidates could see a question relating to this in their exam. In this article we look at the main taxes that usually apply to a buy-to-let (BTL) property.

Let’s first consider the position for someone that wishes to buy their first BTL.

Let’s imagine the purchase price of a BTL property is £250,000. Along with costs such as solicitor’s and estate agent’s fees, the biggest cost will be stamp duty land tax (SDLT). In April 2016 the tiered rates were increased by 3% for the BTL investor. This means that the first £125,000 is charged at 3% (£3,750) and the next £125,000 is charged at 5% (£6,250) – in total a whopping £10,000 just on tax. (Prior to April 2016 the SDLT would have been just £2,500).

If this doesn’t put investors off the next tax to consider is income tax on rental income. Rent is charged to income tax at the landlord’s marginal rate and they must declare it through self-assessment. Various expenses can be deducted for example insurances paid by the landlord, repairs and maintenance and any fees paid to a letting agent (amongst other things). Any of these deductions will save income tax at the landlords’ highest marginal rate.

Before 2017 what also could be deducted for full income tax relief was any interest being paid on a mortgage loan. Being able to deduct the full amount of mortgage interest made rental property an attractive investment especially to those who were also taking full advantage of pensions flexibilities and accessing funds at age 55.

Changes to the rules

From April 2017 all this changed when tax relief for interest on BTL mortgages started to be restricted to the basic rate of income tax, ie 20%. In 2017 the deduction for full tax relief was restricted to 75% of the finance costs, with the other 25% being allowed as a basic rate tax deduction only.

In 2018 the split became 50%/50% and from April 2019 it will become a 25%/75% split (25% of finance costs will be deducted for full tax relief with 75% being relieved at 20%) and as from April 2020 all finance costs will be given as a basic rate tax deduction.

Another implication now that profit from rental income is worked out without deducting full interest costs is that taxable profits will be higher. This could impact a basic rate taxpayer who is pushed into the higher rate band and it could push a higher rate taxpayer into the additional rate band. It might affect other things such as child benefit claims if earnings are now over £50,000 and a reduction to someone’s personal allowance if taxable earnings are over £100,000.

Less attractive investment

It’s clear that choosing to enter the BLT market is not as attractive an investment as it once was. Many landlords will have reduced financing costs or considered a company structure (which would have other tax consequences) or perhaps they just increased the rent or exited the market completely with the additional blow that capital gains tax (CGT) on the sale of second properties are charged at 18% for a basic rate taxpayer and 28% for higher and additional rate taxpayers. Expenses can be deducted such as the stamp duty land tax and fees (both legal and estate agents) as well as any costs that have been incurred for enhancement and there is also the annual exempt amount which can be used if available (which is £12,000 from 6th April 2019).

Others may have considered turning their BTL into a furnished holiday let (FHL); these are treated as a trade and as well as not being subject to the changes to mortgage interest relief (they can still offset all of their interest costs) they also enjoy other advantages not available to the BTL investor such as CGT rollover, holdover relief and entrepreneurs’ relief, profit is classed as relevant earnings so can be used to make pension contributions and capital allowances can be claimed on plant and machinery (eg, furniture and kitchen appliances).

To qualify as a FHL, the property must be in the UK or in the EEA, it must be commercially let for profit (ie, it can’t be let to family and friends with no or little rent) and as you may have guessed, it has to be furnished. The occupancy conditions are that it must be available for let for 210 days in a year and the minimum period the property must be actually let in a year is 105 days.

These advantages could provide an unhappy landlord with an attractive and viable alternative.

Article first published in Professional Paraplanner magazine, April edition

Further information on exam questions can be found on the Brand Financial Training website: https://brandft.co.uk