Optimising your tax position as a UK homeowner

On the face of it, tax surrounding property and letting in the UK can seem pretty straightforward, but new research from our team of accountants in London has shown how private homeowners can optimise their tax position with regards to buying, refurbishing, renting and selling property.

Previously, if you’ve bought a property and decided to rent it out, you would not immediately get the full tax relief on the money spent in refurbishing the property as expenditure of this nature is capital expenditure and therefore not deductible against rental income, but deductible against future capital gains instead.

Homeowners who live in their property do not pay capital gains tax due to private residential relief, however, this relief is reduced when a property is let and capital gains tax subsequently becomes payable.

Landlords in the UK can claim letting relief to reduce their capital gains tax, but any capital gains calculation is complicated on and professional tax advice should be sought.

New laws on mortgage payment tax relief

New tax laws around tax relief for borrowing interest for sole traders were announced by the Government last year and will be coming into effect for the first time in the current tax year.

Landlords whose income falls in the higher tax bracket of 40% will see their tax reliefs fully wiped over the next four years as part of a phasing-out scheme. Currently, the plan is to reduce tax reliefs by 25% every year until they cease to exist. However basic rate tax relief is still available.

The Chancellor, Philip Hammond, slashed the tax relief that landlords in the top tax brackets receive on their mortgage interest payments, cutting it from the higher income tax bands, 40% and 45%, to 20% by April 2020.

However, some homeowners have been exploring alternative ways in which they can buy a property, with the view to refurbishing to add value and letting, while also minimising the tax they are liable to pay under the new guidelines - setting up a limited company.

Incorporating your rental business

As a form of counteracting the new regime, private landlords who are facing the above losses could protect their income by turning their rental activities into a limited company.

The Government claim the new guidelines are trying to level the playing field and that it was unfair that landlords enjoyed this tax perk but owner occupiers did not.

Small business accountant, Accounts and Legal, has shed light on the alternative route into buying to let, showing that if a private landlord transfers one or more properties into a company structure, the total tax rate can potentially be reduced over the long-term, with the contrast being that over the short-term stamp duty will need to be paid.

Care should be taken when considering how long any investment is willing to be held as any profit on the sale of a rental property by a limited company would be chargeable to a higher rate of capital gains tax, meaning a 1% increase in comparison to the rate of tax paid by an individual seller.

Full tax relief would still be available for any additional expense incurred by borrowing by a limited company. The reason being is that a company is paying tax on the actual profit and therefore the rate does not fluctuate wildly. If the profit reduces, so does the tax.

If the rental property is run privately, there is a scenario where because you no longer get full tax relief for your borrowing interest expense, you can pay tax even if there is no profit. That means potentially enormous effective rates of tax. If you buy properties under a limited company, you can pay yourself dividends. There are, however, different rules in terms of taxation for those who are UK resident to those who are not UK resident and you can read more about the different rules for resident vs non-residents in relation to the receipt of dividends via the above link.

Refurbishing property

Landlords looking to get tax relief against any income for refurbishment costs need to carefully consider the nature of the expense as there is a thin line between what is classed as capital expenditure, which would be reduce any tax payable upon sale of the property, and expenditure that is deductible against rental income.

If the owner is a sole trader, they would pay stamp duty again on the incorporation of the business based on cost of the property. But if the owner is in business with a partner, they could enjoy some stamp duty relief.

Although incorporating your business helps you guarantee your monthly tax bill, it is not a magic solution. Tax is only one consideration when forming a company and it is strongly advised you speak to an expert before going down this route.

Get in touch with our tax accountants and discuss how their extensive knowledge can help you put your best foot forward.

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