Section 24 and limited companies have dominated our tax pages in recent months – yet not all landlords are affected. Here Michael Wright of RLA tax partner RITA4RENT looks at the top 10 most popular landlord tax questions.
While Section 24 is very important to a lot of landlords, at the same time there are many landlords who are not affected by these changes. Our most frequently asked questions cover both of these camps – and deal with everything from repairs to capital gains allowances.
When is a repair a repair? One of the most common areas that people misunderstand on their tax return is when to claim an expense as a repair, and when it should be a capital cost. A simple repair definition is restoring something to its original state. The boiler goes pop, and Mr Plumber comes in and fixes it.
Beyond Section 24 Section 24 and limited companies have dominated our tax pages in recent months – yet not all landlords are affected.
What can also be claimed is a like for like replacement of an item that is fixed. This could be replacing a similar standard toilet, bath and sink. This can be claimed as a repair. In the same example, if you then decided to add a shower to the bathroom, you are adding something and not replacing it, and you therefore have a capital cost. Just to confuse the issue, there are special rules regarding an improvement over a passage of time. The standard example here is replacing single glazed windows with double glazed ones. This is considered to be the nearest modern equivalent in terms of standard windows now so, despite the element of improvement, this is usually considered to be a repair cost.
Can I claim for mortgage fees?
The incidental costs of raising finance were deductible until 2016/17. Now they are subject to the same rules as mortgage interest but nonetheless that still means a 20% tax deduction from 2020/21. This includes costs such as arrangement fees, broker fees and admin fees.
My spouse earns a lower income than me.
Can we make use of this for income tax? You will need to make a declaration of trust to the spouse you want to transfer the lion’s share of the income to and then send a copy of this, plus a Form 17 to HMRC. If the beneficial ownership doesn’t match the declaration of trust in percentages, your application will end up in the HMRC bin. A solicitor would normally be able to advise on the declaration of trust. There is a stamp duty consideration here, in that if there is a mortgage, this will be deemed to be consideration for the transfer i.e. one spouse is taking the liability off another spouse. As of 22 November 2017, the rates charged are the standard rates where husband and wife are involved. Therefore, if the transfer of mortgage involves less than £125,000, no stamp duty will be payable. Confused? Have a look at this example. Property X has a mortgage of £100,000 and is owned by Husband entirely. Husband is a higher rate taxpayer and wife is a basic rate taxpayer. Husband transfers 90% to wife. The consideration is £90,000 as this is 90% of the mortgage. As this is below £125,000, no stamp duty. If the mortgage had been £200,000, the consideration would have been £180,000. As this is above £125,000…. Stamp duty.
You should note there are no capital gains tax implications between husband and wife as such, although any such capital disposal still has to be reported on the tax return and the spousal exemption claimed to reduce the gain to Nil gain/Nil loss.
Is it better to operate via a limited company or personally? Many considerations here. Reasons for include: potentially lower corporate tax rates at 19% and 17% in 2020, mortgage interest is still fully claimable, you can retain profits in a company and reinvest year on year, and of course the benefit of a director’s loan account which means any money you loan the company you can take back tax free, such as if you purchase a company property with your own cash. Reasons against include: Potential to pay both corporate and income taxes, such as by use of dividends, the difficulties involved in moving existing properties, and – the reason which is often not touched on enough – the extra accountancy fees you can expect to pay. The last can be all well and good an accountant demonstrating you will save £500 in tax. However if his fees are £750 more than you would have been paying, you’re still out of pocket! This really has just scratched the surface as a lot of time can be spent going through this question.
Could we transfer existing properties in to a company? This was touched on in the previous question and the answer is yes, but for a large number of landlords it will be expensive. The “large number” we refer to will own just one or two rental properties and could end up paying capital gains tax (CGT) based on the gain at the date of transfer. The company could also pay a lot of stamp duty for any property worth more than £40,000. Ouch, not attractive. This is the point where most landlords will stop reading. For larger landlords it would depend if you could justify that you are running a business rather than just having investment properties. This depends on several factors outlined in the Ramsey case. Broadly this relates to having a lot of time spent on the business, significant turnover from it and it representing a large amount of your income. Again, if you think you may go down this route, it is important to talk this through with an adviser as there is a lot more depth here. Should you be able to demonstrate this, it is possible to structure the business as a partnership and, in a few years, transfer the properties to a limited company deferring any CGT and having no stamp duty due at transfer.
What about a management company?
The reason for doing this is generally because of the lower tax rate of a company compared to that of a higher or additional rate taxpayer. The management company charges a management rate to undertake management services for the properties and this can be claimed as an expense in the tax return reducing your income tax bill. There are two important factors here. Number 1:is the accountancy cost of a company going to outweigh any tax saving (as per question 5) and am I running a genuine management company that is not just set up for the avoidance of tax? Number 1 is a pretty straightforward cost/benefit analysis. Number 2is where landlords can run in to serious trouble. There is anti-avoidance legislation which, where a transaction or structure is solely for the avoidance of tax, can put you in the position you would have been in before in terms of tax plus adding any interest or penalties. Bad news! Therefore, if you set up a management company you would need to have written agreements in place listing the service the management company would undertake, a commercial rate that you expect to pay to another managing agent in that location and it also helps if you manage properties that are not owned by you.
What stamp duty charges do I have to pay on a second property?
Assuming the property is purchased for more than £40,000 you will have to pay the standard rate plus 3%. This is subject to the exemptions mentioned earlier with husband and wife transfers. The other exemption would be if the property replaced the main residence within three years of selling the first residence. There are many other considerations, but this is the very short answer.
What can I do with any unused Capital Gains Tax annual allowance? Unfortunately, if a year passes, and you do not use your full annual CGT allowance, then that’s it, it’s all gone. You may only offset your annual CGT allowance against any gains arising in that specific tax year. Even if say, you sold a property and realised gains of £5,000, the remaining annual allowance can only be used against any other gains in this year, otherwise they will be lost. It is worth pointing out too that annual allowances cannot be passed between spouses, but should a husband and wife team sell their jointly owned property, both their annual CGT allowances can be added together to offset against any gain arising, assuming it has not already been used up.
I really thought I had made a loss in the past, but have just realised there was a small profit, and have not been declaring this to HMRC. What should I do? While it is not a good position to be in, the reality is not nearly as scary as you think, but if there is backdated tax to pay, you must take action! HMRC’s Let Property Campaign will allow you to bring your tax affairs up to date on the best possible terms. A good property tax advisor is highly recommended. If, however you were unaware of the great number of expenses which may be offset against rental income, and it turns out you did actually generate a loss, then you may be able to simply register for selfassessment and bring this loss into your first tax return, assuming these arose within the last four years.
I am a member of the Residential Landlords Association. Can I claim my membership fee as a cost on my selfassessment tax return? In HMRC’s property income manual, section PIM2120, they state you may claim for: “subscriptions to associations representing the interests of landlords.” As such, the good news is that it is indeed an allowable deduction and can be included on the property pages of the self-assessment tax return.