(Residential) Property Is Dead! Long Live (Commercial) Property!

If you let out a residential property, you shouldn't underestimate the effects of some important changes to the tax rules.

Tax is like any other cost. It reduces the return you get from your asset. Therefore if your tax cost increases, your return decreases and this may affect your view as to whether your property remains a good investment.

If you are a basic rate taxpayer, be prepared to be taken into a higher rate tax bracket or child benefit to be taken away, effectively another tax charge.

If we assume you're an employee, with two children, earning a £47k salary and property profits of £3k, your gross income is £50k. Assuming your spouse isn't earning more than £50k, you get to keep all your child benefit.

Your £3k property rent is calculated as follows:

Rental income  £7,000

Interest            (£3,000)

Agent fees          (£400)

Insurance           (£100)

Other eg repairs (£500)

Profit                  £3,000

On which you're paying 40% tax of £1,200. If your property is worth £120k, you're receiving a modest after-tax return of 1.5%. 

However, this picture changes when the new rules, starting next April 2017, are fully in place in 2020. The interest of £3k above is no longer deductible and your taxable property profit doubles to £6,000.

Your gross taxable income is now £53k. So what?

1. More of your income is now taxed at 40%, rather than 20%.

2. Your child benefit now starts to be withdrawn.

On these figures the additional tax due on top of the £1,200 is:

Child benefit withdrawn           £536

Additional higher rate tax      £1,200

Less 20% interest tax relief    (£600)

Additional tax                         £1,136

Your modest after-tax return is now reduced to £664 (£3,000 profit - £1,136 new tax - £1,200 current tax) of £120k which is 0.5%!

Similar considerations apply for taxpayers near to the £100k gross income level as you'll start to see your tax free personal allowance allowance withdrawn at income above £100k. 

If you rent out a furnished property you're currently enjoying an additional tax deduction of 10% of £7,000 saving you £280 of tax. This will be withdrawn from this April 2016, reducing your net of tax returns even further.

You may ask yourself whether it's worth the hassle! 

If you do still benefit from capital growth, remember that when you sell the property HMRC will require the capital gains tax within 30 days of exchange, so make sure the gap between exchange and completion isn't longer than 30 days so you have the funds available. Please remember to include your accountant before exchange!

You may want to look at transferring or putting new purchases into a limited company which doesn't suffer all these changes. However, currently, banks seem reluctant to lend to these companies. 

Commerical Property

Comparatively speaking, commercial property is now looking very attractive. It isn't going to suffer from any changes and also enjoys lower stamp duty rates. It can be held within a pension wrapper and benefit from those tax advantages. This may be enough to entice you to look at something different and compare the returns. After taking appropriate advice of course.