Chancellor George Osborne recently announced new rules from 2017 restricting tax relief on mortgage interest to the basic rate, currently 20 per cent.

The limits on mortgage interest relief only apply to individuals. Tax relief on mortgage interest was an attractive perk of buy-to-let. A higher rate taxpayer can get 40 per cent relief, but from 2020 will see that halved to 20 per cent. Landlords will be taxed on their rental income not their profits.

A company only pays tax on its profits whereas an individual pays tax based on their income and companies pay a lower tax rate than individuals. Corporation tax is currently 20 per cent and is due to drop to 18 per cent by 2020.

Landlords could look to preserve some of their profits by setting up companies instead, but experts warn this would be costly for those with just one or two properties. There will be tax charges such as stamp duty and capital gains tax (CGT) that could be incurred when moving property into a company. If an individual transfers their property into a company they set up, there would be deemed as a market value disposal for CGT purposes. If your buy-to-let property has gone up in value since you acquired it, you would have to pay CGT of up to 28 per cent. Also, transferring a property into a company will give rise to a stamp duty liability.

How much tax will landlords pay?
Landlords pay income tax on rent that they receive. The amount paid is determined by their income tax band. A basic rate taxpayer pays 20 per cent, while a higher rate taxpayer pays 40 per cent and tax is 45 per cent for additional rate taxpayers. Income from rent is added to personal income from other sources to decide the tax rate.

However, landlords can currently claim relief for interest on buy-to-let mortgage payments, allowing them to offset their mortgage interest against rental income and only pay income tax on the gap between the two – i.e. their profit.

As an example, currently someone who receives £1,000 a month in rent and has an interest-only mortgage payment of £600 only pays income tax on the remaining £400 that amounts to their monthly rental profit. For a 40 per cent taxpayer this would mean a £160 tax bill, leaving them £240 profit.

Under rules being introduced in April 2017 the tax relief will be reduced up to 2020 when it will be set at a maximum of 20 per cent. At that point the investor in the example above would face a £280 tax bill, leaving them with £120 monthly profit.

With interest rates expected to rise sometime in the next year, buy-to-let landlords with significant debt will see a reduction in tax relief, which will naturally result in higher costs and lower after tax profits.

One alternative, is for landlords to manage the properties through a business.
There are already many benefits to managing a buy-to-let portfolio through a company rather than as an individual, but changes to tax relief mean this route could be more effective for higher rate taxpayers.

Do you need access to the money?
If you are running your property as an individual then any profits after tax will be in your name and easy to access. It is slightly more complicated if you want to draw some money from a business and one option is to take the money out in the form of a dividend. However landlords need to be aware that from next year dividend income will be charged at 7.5 per cent for basic rate taxpayers, 32.5 per cent for those on the higher rate and 38.1 per cent for the additional rate band. This could be alleviated by the tax-free dividend allowance of £5,000 being introduced next year.

Overall, for buy to let investors it is probably best to set up a company if you want to roll up the money and don’t need access to it. You could just use it to build up a pension pot for when you retire.

Are you ready to run a business?
The HMRC has very few requirements for individual landlords. They just have to complete a self-assessment tax return each year that takes account rental income and any expenses and reliefs.

Businesses have a range of responsibilities such as completing annual returns and accounts, all of which could mean paying for an accountant. It could also get more complicated if you start involving shareholders and different directors.There are costs and hassle associated with running a company. This is only really beneficial for serial buy-to-let landlords with a portfolio of at least 10 properties. For those with one or two properties, the associated costs and administration involved with operating a company is unlikely to make it worthwhile.

For personal financial advice contact your accountant.

About Tom Morgan

Founder of Jungle Property the multi award-winning letting agent based in Glastonbury, Somerset. I am passionate about property and Glastonbury and about providing the very best advice to anyone who wants the best return on a buy-to-let property investment. For an open and brutally honest opinion on anything in the Glastonbury property market please contact me via tom.morgan@jungleproperty.co.uk

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