Many doctors have rental properties – either where original homes have been rented out or as investments in ‘buy to lets’.
Recent changes in tax laws have made it more complicated. Starting with the good news:
The existing 10% wear and tear allowance on furnished lettings will be replaced by the actual amount spent on replacement furnishings, including cookers and fridges.
The new replacement furniture relief will apply for the tax year beginning 6 April 2016 (1 April 2016 for companies) to landlords of unfurnished, part furnished and furnished properties. This appears to be good news for those landlords who let unfurnished property which contains cookers, fridges and washing machines. Please note that the initial cost of furnishing a property will not be allowed.
The relief will not apply to ‘furnished holiday letting’ businesses (FHLs) or to lettings of commercial properties, because these businesses receive relief through the capital allowances regime.
The new relief will be to cover the capital cost of replacing items provided for a tenant’s use in the dwelling
- fridges and freezers
- carpets and floor-coverings
- crockery or cutlery
- beds and other furniture
The cost of replacing fixtures such as baths and boilers will continue to be deductible as now.
Please be aware improvements will not be deductible. An example would be where a washing machine is replaced by a washer-dryer, where the additional cost of having the improved item would not be allowed.
Top Tax Tip
If you are considering changing or replacing any items listed above, we would recommend that you wait until 6 April 2016 (1 April 2016 for companies) so that you can get the full deduction of the cost against letting income. If you incur the expenditure before this date you will not be able to claim a deduction.
And then the trap...
Tax relief for interest on property-related loans
The restriction of financing costs for individual landlords of residential property is not a simple reduction in tax rate, but a change from a deduction of interest, to a relief that reduces the tax payable.
The following example shows how a landlord who makes a loss from letting will pay income tax in 2020/21.
Helen is a single GP with 2 children who earns £35,000 (see table opposite). She is entitled to child benefit and pays tax at the basic rate. She lets out her former family home for £24,000, and rents a small flat. The let property has a large mortgage attached so the deductible interest is £26,000. Helen thinks she won’t be affected by the Summer Budget changes as her marginal tax rate in 2016/17 is only 20%.
Her income remains constant, but in 2020/21 her personal allowance is assumed to be £12,500, and the basic rate band: £37,500. However, in that year all of the interest she pays on her let property mortgage is disallowed as a deduction, and instead she receives a tax credit to set against her tax bill:
|2016/17 (£)||2020/21 (£)|
|Total net income||£35,000||£59,000|
|Basic rate band limit||32,000||37,500|
|Property loss carried forward:||(2,000)||0|
|Tax charged @ 20%||4,800||7,500|
|Tax charged @ 40%||-||3,600|
|Tax credit on interest at 20%||-||(4,800)|
|Loss of child benefit||-||1,789|
|Total tax payable:||£4,800||£8,089|
In 2020/21 Helen is a higher rate taxpayer and she loses her child benefit because her total income is over £50,000.
The tax credit is calculated as 20% of the lower of:
- Finance costs not deducted from income (£26,000)
- Profits of the property business (24,000)
- Total income exceeding allowances (46,500)
Her lettings business has made an accounting loss of £2,000, but she pays tax on the rent of £3,589 (having had £4,500 deducted under PAYE for her salary). If interest rates rise, then this will make the problem even worse.
As her actual finance costs are £26,000 she will be able to carry forward a tax credit of £400 (20% x £2000) to set-off in a later year.
Helen has little choice but to sell her only let property as she has no other resources from which to reduce her borrowings. Other landlords may be able to sell part of their property portfolio, or restructure their lettings business in one of the following directions:
- sell residential property and reinvest in commercial buildings
- let the residential property as furnished holiday lettings
- transfer the properties into a company.
Any of those options will allow a full deduction of interest and other finance costs from the rents received, but the transition will involve CGT and SDLT costs. Also the mortgage provider must co-operate with the transfer of loans to a company, and it may require higher rates of interest on a corporate loan. Seek professional advice before making any of these changes.