Upcoming tax changes: what is incorporation?

It is now only a few months until the phasing out of mortgage interest tax relief begins – from April 2017 landlords will no longer be able to claim tax relief at their marginal rate of tax. Instead, the maximum tax relief for all landlords will be set at the basic tax rate of 20%, which is expected to have an adverse effect on the profits of a significant proportion of landlords.

The changes will be phased in over the next four years, to ensure they are fully implemented by April 2020. Landlords and industry bodies have long been in opposition to the cuts to mortgage interest tax relief, but – despite lobbying, court battles and regular calls for the government to change (or soften) their approach – the proposals will come into play as they were originally planned.

As such, landlords have been looking for ways to ensure their profits aren’t too badly hit. One such way has been incorporation, which involves landlords converting their property portfolios into limited companies in order to pay lower levels of corporation tax and lower taxes on profits. While putting your property into a limited company structure is likely to limit your range of mortgage options, you would also be able to pay lower tax on any profits you make.

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Taking this step has become increasingly popular as the prospect of a change in heart from the government has become more and more remote. An increasing number of buy-to-let investors and landlords have been setting up limited companies to guard against the worst aspects of the new incoming legislation.

Towards the end of 2016, the number of applications for buy-to-let properties made by landlords using limited companies soared, according to Mortgages for Business’ latest ‘Limited Company Buy to Let Index’.

The Index revealed that the number of purchase applications made through a limited company structure rose by 6% from Q3 2016 to Q4 2016, significantly more than the 21% figure recorded before the changes to mortgage interest tax relief were announced by former Chancellor George Osborne in his 2015 Summer Budget.

Since Osborne’s announcement – and the slow but steady realisation that the government would not be budging on its planned proposals – the behaviour of landlords has changed considerably, with many keen to mitigate the potential dents to profits by finding ways of avoiding or minimising the impact of the tax changes.

This is further backed up by research carried out by Kent Reliance, which found that more than 100,000 landlords incorporated in 2016. Over 100,000 limited company mortgages were issued in the first nine months of last year, double the overall number in 2015 as a whole.  What’s more, in Q3 2016 the rate at which limited company loans were issued was more than 12,000 a month.

A survey conducted by Kent Reliance showed that 11% of landlords have already incorporated; while a further quarter (25%) are weighing up a similar move.

As well as putting property portfolios into limited company structures, other ways in which landlords are trying to avoid feeling the pinch include switching to shorter-term fixed-rate mortgage deals to secure a lower interest rate (although this, of course, is a potentially risky strategy).

In addition, there is the option of transferring ownership of one or more properties to a partner or spouse, if this partner or spouse pays less tax and will be less affected by the tax relief changes. A person paying the basic rate of tax (20%) will see no difference when the changes are introduced, whereas a higher-rate taxpayer (40%) and a top-rate taxpayer (45%) are likely to see their profits reduced considerably.

As with all financial matters it is essential to get the right advice on the landlord’s specific circumstances before making any changes. This is particularly important with incorporation affecting property portfolios.  Advice should be sought on the downside of such a step, and landlords should also weigh up, and seek advice on, the possibility of the Government tightening up the rules for landlords in this area and making the option less attractive.

For more information about the upcoming tax changes, and how you can get the most from your rental property, please contact Letting Solutions on 01506 496 006.

As West Lothian’s first dedicated lettings agency, we use our experience and knowhow to help you make the most of your portfolio.

We also provide free and instant online valuations to help you estimate how much you could be charging in rent each month.