With the first phase of George Osborne’s restriction of mortgage tax relief coming into effect in April, Robert Maas, Tax Consultant at London accountants, tax and business advisers CBW, gives guidance on how buy-to-let landlords can bypass the restriction.
Many, if not most, accountants think that incorporation is rarely attractive. While this reduces the tax on the interest to 19%, it increases that on distributed profits from 40% to an effective rate of 45.325% for a 40% taxpayer and significantly more if the money is taken out as salary, so attracting National Insurance.
Furthermore, it increases the tax on property disposals from 28% to an effective 35.4% and to get that rate, locks the gain inside the company until it is liquidated. If landlords want to utilise the money outside their property business without shutting it down, they may have to suffer the 45.325% rate.
A possible alternate strategy is to reduce the interest charge either by repaying part of the loan or refinancing it. The interest rate on home loans is normally less than on buy-to-let loans, so increasing the mortgage on your own home and using the extra borrowing to repay your buy-to-let loan can make sense.
The fact that the loan is secured on an asset outside your property business does not affect the allowability. The test is what the money is used for, so the nature of the security given to obtain the borrowing is irrelevant.
A possible downside is that using your house as security effectively makes your family hostages to the lender. If landlords default on the buy-to-let loan, the bank may come after them, but cannot attack their spouse. If the borrowing is on their home, the bank will want the spouse to agree to a charge on his or her interest in the property too, so defaulting could put the whole family on the street. On the other hand, banks have traditionally been reluctant to render their customers homeless, but have no such compunction when it comes to tenants. Accordingly, it may be easier to agree some sort of a deal on a home mortgage.
There are also some attractive interest rate deals around for five-year fixed term loans at present. That means taking a view on future interest rates, but the risk of them going down is probably not that great. The bigger snag is that if rates rise, it might be difficult to secure a new loan at an attractive interest rate in five years’ time. There is also likely to be a penalty for early repayment if investors are forced to sell the property while the loan is outstanding.
Another possibility is to divert part of the rent to adult children who may have little or no income, so will pay tax at only 20% on such diverted income. Reducing tax on the net income from 40% to 20% has the same result as reducing the tax relief on an equivalent amount of interest from 40% to 20%. The children can use the money themselves to pay for something that parents otherwise would have provided for them.
The simplest way to do this is to gift an interest in the property. There is no stamp duty on a gift to another individual unless they take over part of the liability under the mortgage. It’s possible to gift an interest in the property and retain 100% of the mortgage liability, although this may require the agreement of your lender.
An alternative is to gift only a right to income. HMRC acknowledges in its Trust, Settlements and Estates Manual that you can pass income to, say, the kids at university without passing a share in the property to them, provided that parents enter into a formal declaration of trust. This doesn’t work for children who are under 18 and unmarried. It also needs to be borne in mind that gifting a right to income, which is what they would be doing, has potential capital gains tax (CGT) and inheritance tax consequences.
For CGT, landlords will be disposing of an interest in the property. This is only a problem if the gain attributable to the value of what is gifted exceeds your CGT annual allowance. This depends on what is given away. Giving away the right to receive a percentage of the income for 10 years is a valuable gift, but giving it away until such time as landlords decide to terminate the arrangement by giving three months’ notice is unlikely to pass a significant value. Inheritance tax is likely to be an issue only if a person makes a gift within seven years of their death.
Finally, buy-to-let landlords who are concerned and unsure how to proceed should seek professional advice from a tax specialist sooner rather than later. To find out more, contact Robert Maas on (0)20 7309 3800.
Robert Maas is a Tax Consultant at London accountants, tax and business advisers CBW (www.cbw.co.uk). He has over 50 years’ experience in tax and is one of the UK’s leading tax experts. He is author of Property Taxes (http://www.bloomsburyprofessional.com/uk/property-taxes-201617-9781784513351) and contributor to Buy-to-let Property Tax Handbook (http://www.bloomsburyprofessional.com/uk/buy-to-let-property-tax-handbook-9781784510541), both published by Bloomsbury Professional.