If you have clients who have geared property portfolios they could be in for a shock next year.
The government have decided to restrict tax relief on mortgages to basic rate, resulting in a significant increase in landlords tax bill where they have significant gearing.
The changes will be staged over 4 years with a 25% restriction on higher rate relief in 2017/18, a 50% restriction in 2018/19, a 75% restriction in 2019/20 and a 100% restriction on higher rate relief in 2020/21. This also means for those wealthier clients with incomes above £150,000 who are currently able to relief mortgage interest at 45% this will be capped at 20%.
With the restrictions in place landlords will find themselves with an unexpected extra tax bill (plus half again as a payment on account). Where the rent only covers the interest and costs of running the properties this will mean clients having to fund the tax from their other income or potentially having to sell properties to pay the tax.
How does this affect your clients?
Assuming a reasonably low interest rate of 4%, 75% gearing and a healthy net profit before interest and tax of 5%:
A client with a £1m gross portfolio would suffer additional tax of £1,500 in the first year, £3,000 in the second, £4,500 in the third and £6,000 a year extra tax thereafter.
A client with a £2m gross portfolio would suffer £3,000 extra in the first year, £6,000 in the second, £9,000 in the third and £12,000 a year extra thereafter.
However, for those clients that are currently breaking even this could result in a very significant additional tax charge which they would have to fund through other sources.
What are the options?
The first thing to do is obviously make clients aware of the change. The simple solution is to incorporate the business, in a perfect world this is a clean and simple process. However, there are a number of complications, including SDLT, CGT and extraction of profit from the company.
We can assist with a review of the incorporation route, especially where there is a small number of properties.
Where there are considerable in built gains this will have to be carefully weighed up, although there are opportunities to structure any incorporation tax efficiently to mitigate any CGT.
Finally where clients have considerable property portfolios (£2m upwards) it may be worthwhile thinking through a complete restructuring of how the property is held.
The pension solution
By incorporating your rental portfolio into an international pension it may be possible to:
remove the impact of the changes
shelter your fund from IHT
extract profits far more efficiently
protect your portfolio from creditors
For clients who have considerable equity in their portfolio this route can save significant income tax on an ongoing basis and save hundreds of thousands of pounds in IHT, while still offering them the flexibility to run their portfolio as usual.
To find out more, contact Anthony Rogers today.