As a controversial new tax passes through parliament, an alternative to traditional property investment promises to provide a tax-efficient way to gain entry to the UK’s thriving buy-to-let market.
George Osborne’s announcement, in the 2015 Summer budget, will see the gradual removal of tax relief on the interest component of buy-to-let mortgages, meaning that, from 2020, landlords will be unable to deduct mortgage interest costs from their rent.
The consequence is that landlords will be paying tax on their rental income, as if it were profit - despite having to pay interest to a mortgage lender. In extreme cases, this could see individuals paying tax, even when the property itself is making a loss.
While some landlords are already taking steps to safeguard themselves from the changes – which will begin to come into effect, under transitional rules in April 2017 – many are concerned that they will need to look at increasing rents to counterbalance the impact of this new tax. Others are looking at selling their investment properties, or using cash savings to reduce their mortgages in a bid to avoid the additional levy.
Propnology.co.uk – a recently launched property crowdfunding platform – offers an alternative solution; this enables individuals to invest, alongside like-minded investors, in a tax efficient corporate structure, which is not affected by the new tax. The use of a company structure, where each property is purchased within its own Limited Company, allows expenditure to be offset against the profits and the company incurs corporation tax as opposed to personal taxation.
Whilst property crowdfunding is not an entirely new concept, the Propnology platform is the first of its kind to offer a diverse range of investment opportunities, across both residential and commercial property classes, with opportunities throughout the UK. The platform is also one of the first to be directly authorised by the Financial Conduct Authority (FCA) and allows individuals to invest from as little as £500.
An example of the new tax regime, assuming you are a landlord who pays 40% tax:
Current Tax Rules
You own a buy-to-let property which generates an annual income of £10,000, with interest-only mortgage repayments of £6,000 a year. Tax is currently due on the difference – meaning you pay 40% tax on £4,000. This equates to a tax bill of £1,600 and a net profit, to the landlord, of £2,400.
2020 Tax Rules
From 2020, tax will become payable on the full rental income of £10,000 – less a tax credit, equivalent to the basic rate tax of 20%, on the interest payments. The landlord will therefore pay 40% of £10,000 (i.e. £4,000), minus 20% of the £6,000 interest-only mortgage payments (i.e. £1,200). This results in a tax bill of £2,800 and a net profit, to the landlord, of £1,200.
In this example, the tax bill has gone up by an astonishing 75% and the net profits have decreased by 50%.
To further extend this example, if the mortgage interest rate were to increase by an extra £100, resulting mortgage payments of £7,200 per year, the tax due would remain the same at £2,800 - the landlord would make no profit at all and any further rate increases would result in a loss.