The individual owners of rental homes are facing new challenges, both economically and financially.
The UK housing sector is currently under pressure, with potential buyers and tenants running out of opportunities. In the rental sector, there have been signs of a decline in the number of rental properties as owners seek to sell and withdraw from the residential rental market. Soaring costs and recent tax changes largely explain this trend.
Costs are rising on many fronts. Many of these will hit renters, for whom higher energy bills and other living expenses take away some of the additional disposable income. Then, of course, there’s the spectre of big rent increases, which may not be affordable.
For bosses, perhaps the biggest headache is the recent rate hike. These are already follow-up financial costs, which can be multiples of what was paid about a year ago. With the inability to get tenants to raise rents close to what can currently be claimed, landlords face financial costs that rental income may not be able to cover.
For residential landlords, that presents a significant challenge. The tax position, which is examined in this Tax Insight course and includes the following, is an issue that is made worse.
The notes that follow apply to residential homes that aren’t equipped vacation rentals. The tax treatment of furnished vacation rentals is different, and these remarks are not intended to cover the corresponding regulations.
Restricted relief for finance charges
Focusing on the landlord who individually owns residential property, either alone or with co-investors, a troubling situation is being made worse by the recently altered income tax classification of finance expenses.
Finance expenses can no longer be deducted from rental revenue as they were last year. Instead, a credit equal to the basic rate of tax is given to the landlord to offset their income tax due. The lowest of the incurred interest expenses or the amount of rental earnings (before interest) is used for this.
How the financial deduction restriction affects clause
Consider a person who rents out a home and whose earned income is enough to cover both the base rate band and their annual personal allowance. The person’s gross rental income is £25,000, of which £10, 000 is spent on financing and £3, 000 on other expenditures. (Scotland’s tax situation is likely to be different from the one discussed here.)
The individual would have had to pay 40% tax on the £12,000 rental profit (£25,00 less £13,00) in the tax year 2016/17, which was the final year that a complete income tax deduction was permitted for finance expenses related to rented residential property. The corresponding tax was £4,800.
In 2022/23, when only the base rate tax credit is allowed for financial expenses, 40% tax will be charged on £22,000 (£25,000 minus £3,000) and then the credit is applies to a tax of 20 sic against the pound sterling . 10,000 financial expenses. The resulting tax will rise to £6,800. The pre-tax return is still £12,000 but owners must find an additional £2,000 in tax from 2016/17.
If in 2023/24 finance costs double to £20,000, the pre-tax rental yield would drop to just £2,000 without the increase in rent. However, the income tax charge is only reduced to £4,800 as the additional £10,000 finance charge only collects a £2,000 tax credit at the base rate. Owner is now lost £2,800 after tax.
The situation is even worse if the additional financial costs for, for example, 25,000 pounds. The base rate tax credit will be capped at actual rental profits (before financing costs) of £22,000. As a result, the tax liability would only be reduced by an additional £400 (that’s £2,000 at 20%), costing the owner £4,600 more as a result of an additional £5,000 financing cost for just £400. You get a tax break.
In this illustration, the owner’s income is in the 40% tax bracket. As a result, the impact is even greater for owners whose rental income puts them in the 45% tax bracket.
Deferring uncompensated financial expenses
In the event that the tax credit cannot be fully implemented in a year, such as the £3,000 just mentioned, the unresolved ‘excess’ tax credit can be carried forward.
However, this can only be reduced if and when future rent increases generate enough taxable rental income to cover both the deferred credit and the credit due in that year.
Higher CGT for residential real estate profits
Homeowners are also affected when a property is sold with capital gains subject to a higher capital gains tax rate than the tax applicable on capital gains on non-residential real estate – or otherwise capital gains. on any other asset (other than from certain capital gains typically associated with venture capital investments and known as “realized gains”).
Once the yearly capital gains tax exception is surpassed, the lower capital picks up charge rate for private property is 18% (compared to 10% on other resources). This rises to 28% (as compared to 20% on other resources) in case the vender would be uncovered to higher rate pay assess on the off chance that the assessable pick up were included to assessable salary.
The capital picks up exclusion is £12,300 in 2022/23 but, taking after the Chancellor’s Harvest time articulation in November 2022, this is often due to fall to £6k in 2023/24 and after that to £3k from 6 April 2024.
Main housing and rental during absence
In the event that a landlord has used the property as a primary residence both before and after the lease term, such landlord may still be fully exempt from capital gains tax on the principal residence.
In general, a three-year absence does not affect the waiver, and a term of up to four years can be waived if, for example, the landlord is bound by work (or his/her wife’s job/ husband) to live elsewhere (TCGA 1992 , 223(3)).
60-day period to report winnings and pay CGT
Along with non-real estate gains, these need only be reported on the seller’s regular self-assessment tax returns and any related taxes paid by January 31 after the end of the year. tax. This is not the case with taxable capital gains. In this case, the owner must report the liquidation to HMRC within 60 days of completion of the sale and any taxes due at that time.
Exemption from the 60-day requirement provided the owner is a UK resident and the transfer does not generate capital gains tax (FA 2019, Sch.2, Part 1, paragraphs 1-7).
Different rates for residential and non-residential purchases (including hybrids)
Just like income tax and capital gains tax, there is a difference in tax rates between stamp duty and property tax on residential property versus commercial or even residential property. mixed housing and non-residential. This is also the case for property taxes that apply in Scotland and Wales, although the rate is different from the UK SDLT in England and Northern Ireland. For mixed use, a lower non-residential SDLT rate applies to the entire purchase.
The maximum SDLT rate for non-residential properties is 5%, applicable to purchases over £250,000 in the UK and Northern Ireland. On the other hand, this maximum SDLT rate for residential property could be 15% or even 17% if the owner is not resident in the UK. This higher rate comes into effect when the price exceeds £1.5 million.
These rates refer to the purchase price of the title property or the premium paid when a lease is acquired. Where the property has been purchased by leasing under which the rent is payable, there may also be a charge on the present value of the lease cash flows. The SDLT rate in this case is relatively modest, but there is still a disparity between residential and non-residential properties.
3% surcharge
In addition to direct taxation, the lessor or rental candidate who purchases the property will also face the SDLT surcharge, with the exception of the exception where the individual does not own any real estate. other.
The purchase of a second home by individuals in the UK and Northern Ireland is subject to a 3% surcharge on the typical SDLT debt. There are also surcharges payable in Scotland and Wales under their separate property tax regimes, albeit to a slightly different extent.
A 3% increase may apply to the price paid when purchasing the entire title or selling the long-term as well as any premiums paid when the lease is granted. However, in the case of SDLT due to the lease element of a concession to the lease, there will not be a 3% increase.
Extra 2% SDLT surcharge
If the owner is not a taxable resident of the UK, there is also an additional 2% surcharge when purchasing full ownership or rental property.
Two factors make the 2% surcharge quite complicated for anyone handling an SDLT position in a residential real estate transaction.
First, if a property is purchased jointly, a surcharge will apply if one of the joint buyers does not reside in the UK.
The second complication is that the UK residency test is specific to the SDLT. In general, UK residency means that the individual has been in the UK for a period of 183 days in any continuous period of 365 days. This 365-day period begins 364 days before the effective date of the transaction and ends 365 days after the effective date (i.e. there is a two-year period overlapping the effective date).
Unlike the 3% surcharge mentioned in paragraph above, a 2% surcharge can also be applied to SDLT due to the rental element of a concession to the lease.
Ratio of mixed-use and non-residential SDLT
At lower rates for non-residential and mixed-use properties, there have been cases where buyers sought to demonstrate that such properties could qualify for non-residential rates residence, especially when they can demonstrate use of at least a portion of the property other than the purchased home.
Some cases may be simple, for example when there is a commercial facility on the ground floor and one or more upper floors can be used for residential purposes. The same goes for some dental or medical offices, where there may be a similar provision.
However, there have been a number of cases before the court where property has been purchased on land on which ancillary activities or other activities can be carried out. Again, if there is an obvious commercial activity, such as gardening in the market or commercial logging, the mixed-use argument can be very effective.
Some owners may now choose to own investment properties through corporations rather than individuals.
Corporate tax vs income tax
Operating through a corporation means rental profits will be subject to corporation tax rather than income tax. For profits of £50,000 or less, that would be just 19%, compared with 40% or even 45% at the margin for higher earners.
For annual profits over £250,000, the corporate tax rate from April 2023 will be 25%, still better than the higher income tax rate, although fewer owners will benefit from this rental benefit.
Financial expenses
The corporate route has another advantage for homeowners, as financing costs are often a deductible expense against rental income for corporate tax purposes.
Tax on taxable income
A business pays corporate tax on taxable profits instead of capital gains tax.
Since non-corporation owners may be subject to a CGT of 28% on capital gains on real estate, the corporation can increase the tax burden on capital gains.
Disadvantages of business ownership
In addition to the above advantages, it is necessary to mention some disadvantages of owning assets through a corporation.
First, when accrued income or sales profits are derived from a business, the individual owner may be subject to UK tax. If the money is transferred as dividends, shareholders are generally subject to income tax at the highest rate.
If the company is liquidated so that accumulated profits or unsold assets can be extracted during the liquidation, shareholders may be subject to additional taxes. Amounts received by shareholders in liquidation may be subject to capital gains tax, but in certain circumstances HMRC may seek to tax such gains as tax on income in the hands of shareholders. shareholders (see in-depth comment – 328-920: other anti-avoidance rules as of April 6, 2016: introduce).
The transfer of property, which is already privately owned, into a company may result in capital gains tax as well as SDLT (or Scottish or Welsh equivalents).
If the rental business is conducted in partnership, consolidating relief may sometimes be required if the business is transferred to a corporation. This allows capital gains to be “carried over” in the business and so any taxes are deferred until a future sale.
However, HMRC does not necessarily accept that the transfer of an investment business qualifies for this relief, notwithstanding the decision in Ramsey v. Commissioner of Revenue and Customs [2013] 1,868 BTC (to For more commentary on this, see the extended comment section – 574 -150:
Conditions for exemption from company establishment).
The last point is that a corporation can often involve additional management, as corporate accounts must be completed and filed with annual reports at Company House. This is in addition to meeting the company’s tax obligations. Another problem is the annual tax on envelopes residential – or ATED – is likely to apply when the residential property is owned by a business. While tax relief is available for rental property in most cases, it must be claimed on the annual ATED tax return to HMRC.
These are difficult times for “buy and rent” landlords. It remains to be seen what impact all of this will have on future rental housing availability.
