Budget special: 6 ways property investors will be affected

We were anticipating a quiet few years for property investors with the Conservatives in power, but how wrong we were…

The emergency Budget contained a lot that will directly affect investors – among the measures, an absolute bombshell that will have a dramatic impact. In the first episode of our two-part special, we explain the most important changes you need to be aware of – and next week, we’ll discuss what action you should take as a result.

It’s a very number-heavy episode, so you might benefit from reading these notes alongside it…

6 ways investors will be affected

1. Removal of the wear and tear allowance for furnished properties

For furnished properties, you can currently choose the “renewals basis” where you deduct the actual cost of replacement furniture, OR deduct 10% from your taxable profits before calculating tax due.

From April 2016 the 10% option is ending, so you can only claim for the actual replacement cost of furniture.

This is bad news especially for furnished HMOs, where the wear & tear allowance is likely to leave you better off. It also means you can’t reduce your taxable profits consistently every year, so it’s worse for tax planning.

2. Increase in rent a room relief

The tax-free allowance for renting out rooms in your own primary residence is rising from £4,250 to £7,500. Not a game-changer, but a nice bonus for anyone who takes in lodgers or is thinking about doing so.

3. LHA rate frozen for 4 years

The LHA rate used to be pegged to give claimants access to the cheapest 30% of properties in their area, but this link has been broken – and there will be no rises at all for the next four years.

This is a blow for anyone who has LHA as part of their strategy, and may even hold back house prices in heavily LHA areas.

4. Restriction of tax relief on mortgage interest

This is the big one! The ability to claim your mortgage interest as a cost is being removed, and replaced with a tax relief of 20%. It’s being gradually phased in to take full effect in 2020.

The bottom line is that basic rate taxpayers are unaffected, and everyone else will be paying a lot more tax unless they take action.

It’s also important to note that this only applies to individuals: companies holding property can still claim mortgage interest as a deduction.

Let’s take the example of someone who has £10k of annual rental income, with £5k costs in the form of interest payments. (To keep things simple, we’ll forget all other costs.)

Now:
You deduct the £5k interest costs from the income to give you £5k in annual profit. A basic-rate taxpayer pays 20% tax on this profit (£1k) and a higher-rate taxpayer pays 40% tax (£2k).

In 2020:
The £5k interest costs can’t be deducted, so the taxable profit is £10k. Before paying tax on it, you can claim an allowance of 20% of your interest costs (£1k).

The basic-rate taxpayer ends up paying (£2k – £1k = ) £1k in tax – the same as before.

The higher-rate taxpayer ends up paying (£4k – £1k = ) £3k in tax – a lot more than before.

5. Corporation rate tax cut

Corporation tax will be cut to 18% by 2020, which will make it more appealing to hold property within a limited company.

However…

6. Changes to taxation of dividends

The 10% tax credit on dividends is being removed, and instead the first £5,000 of dividends will be tax-free. After that, basic rate taxpayers will pay 7.5% (up from 0% now) and higher rate taxpayers will pay 32.5% (up from 25% now).

This makes it more costly to extract profits from a limited company – and current thinking is that this is just paving the way for further increases, to the point that dividends are taxed at the same rate as income.

Phew! Next week…what to do about it