This site uses cookies. By continuing to browse the site you are agreeing to our use of cookies. To find out more about cookies on this website and how to delete cookies, see our privacy notice.
Analytics

Tools which collect anonymous data to enable us to see how visitors use our site and how it performs. We use this to improve our products, services and user experience.

Marketing

A bit of data which remembers the affiliate who forwarded a user to our site and recognises orders from those who become customers through that affiliate.

Essential

Tools that enable essential services and functionality, including identity verification, service continuity and site security.

Beating the Landlord Tax Rises by Increasing Tax-Allowable Expenditure
By Lee Sharpe, October 2018

Landlords have faced a number of tax-hikes in recent years. New rules mean that relief for interest is being restricted, purchasers of second and subsequent residential homes now face a 3% SDLT supplement, and where a capital gain relates to a residential property, a higher rate of capital gains tax applies than for other gains.

This excerpt taken from our How to Beat the Landlord Taxes report looks at one such provision, which can result in being able to reduce your tax bill as a Landlord. You can purchase the updated report in full here:

>> How to Beat the Landlord Tax Rises

Increasing your expenses in order to pay less tax is a little bit like hiring a taxi to save on bus fares. If you are a Higher Rate 40% taxpayer, then an additional £100 allowable expenditure will save £40 in tax – but it will have cost you £100 already, so you are actually £60 worse off.

But have you claimed all of the tax reliefs to which you may be entitled? In other words, are you getting tax relief on all you can of the expenses that you are already incurring?

Examples of commonly-overlooked expenses include:

  • use of home as an office – typically £3 or £4 a week although, if you can justify higher amounts, then they too can potentially be claimed;
  •  cost of travelling to visit properties, advisers, or business ‘errands’;
  • home office costs, such as claiming Capital Allowances on office furniture, computers, printers;
  •  stationery and postage costs; and
  •  apportionment of mobile/landline telephone and Internet costs to reflect business use.

Since these are costs already incurred but not yet claimed, there will be no extra cost but a saving at the prevailing tax rate.

Paying Family Members

This is a potentially very useful exception to the general rule that incurring additional expenses just to save tax is a bad idea, where the additional money spent ends up as income in the hands of a spouse (or another family member), as salary or similar.

This will benefit the family overall if the paid spouse has relatively lower income, that is subject to a lower tax rate, than the landlord.

Example 1: Paying Family Members

Alex has a property investment business. Alex’s accountant estimates that the tax-adjusted rental profits in the forthcoming tax year (after interest is added back) will be £58,000. Patricia, Alex’s wife, claims £1,800 in Child Benefit for two children and Alex risks having to repay most of that, (around £1,440), as well as paying 40% tax. Patricia, who stopped working to look after their young children and has negligible other income, offers to spend roughly a couple of days a week dealing with paperwork, tenant queries, and book-keeping. They agree that a salary of £8,000 a year is a reasonable reflection of the value of the work that Patricia will do, and Alex duly sets up a PAYE scheme and arranges for the salary to be paid.

At that level, neither tax nor NICs will be due on the amount that Patricia receives, so she will receive the income tax-free. Alex’s taxable income will fall to £50,000, so Alex will save £3,200 in tax (£8,000 @ 40%) and there will be no clawback of Child Benefit, now that Alex’s income has fallen to no more than the threshold at which clawback starts.

HMRC does occasionally look into payments to family members: the payer must be able to demonstrate that the salary reflects the value of real work done or else HMRC will argue that it is merely a diversion of taxable profits and should be rolled back and assessed on the payer instead. There are non-tax limitations on what work young children can do, so it is generally advisable to consider primarily adult relatives.

We shall look at taking family members as ‘partners’ or joint investors, sharing profits rather than taking a salary, in the section on re-structuring the business called ‘Keep It in the Family’.


Planning The Timing Of Expenditure

Generally, the sooner a landlord can get tax relief for his costs, the faster he will see a reduction in his net tax bill and a corresponding rise in his net income. But a person’s net taxable income does not always stay the same every year, so it makes sense to claim tax reliefs when the tax cost is otherwise most punitive, so that the saving is likewise more beneficial.

In Horace above, (and with a watchful eye also on the income levels set out in Potential Traps at section 2.1 above), we can see that Horace is a 40% taxpayer and is likely to remain so, at or around the level of income projected in the example. An additional £100 of tax expense will save £100 @ 40% = £40 in any of the years under review. There is no reason for Horace to do other than claim any additional expenditure as soon as possible. But, this will not always be the case.

Taking the example of Greta above, let’s say that the bathrooms in four of Greta’s properties could do with replacing, at a cost of around £3,000 each. There is no immediate rush and Greta could postpone the repairs for a year or two without upsetting the tenants. And they will be allowable repairs because Greta will be replacing each old suite with a new suite of a similar layout and quality/standard. Assuming Greta has had the choice of 2016/17 to 2020/21, which year would be the best year to incur the cost?

Tax Year:

2016/17

2017/18

2018/19

2019/20

2020/21

 

£

£

£

£

£

Income:

 

 

 

 

 

Net Rent after Mortgage

39,000

39,000

39,000

39,000

39,000

Add-back Rental Finance

0

11,250

22,500

33,750

45,000

Total

39,000

50,250

61,500

72,750

84,000

 

 

 

 

 

 

Tax Liability:

 

 

 

 

 

Initial

5,600

9,300

13,800

18,300

22,800

Student Loan Payable

1,935

2,948

3,960

4,973

5,985

Child Benefit Clawback

0

50

2,501

2,501

2,501

Rental 20% Tax Credit

0

-2,250

-4,500

-6,750

-9,000

Net Tax

7,535

10,048

15,761

19,024

22,286

 

 

 

 

 

 

Net Tax if spend extra

 

 

 

 

 

£12,000 on refurbishment

4,055

5068

7,380

13,144

16,406

 

 

 

 

 

 

Tax Saving on extra spend

3,480

4,980

8,381

5,880

5,880

                                                                          

Tax savings differ significantly from one year to the next, before settling down in 2020/21. The best year to undertake the repair costs is 2018/19. But why?

The key is to work out how much tax Greta is paying on the income she is about to offset with further costs. If we look at Greta’s total taxable income for each year and then compare it to the thresholds in Potential Traps above, we can see that:

In 2016/17, Greta’s income was below the Higher Rate threshold, so she was paying Basic Rate tax of 20% and Student Loan repayments of 9%; her effective tax cost per £1 was 29 pence – a 29% effective tax rate. Additional expenditure would have saved tax at 29%.

£12,000 @ 29% is £3,480.

In 2017/18, Greta’s income was high enough to have surpassed the Higher Rate threshold, (and to have slightly exceeded the point at which Child Benefit started to be clawed back). More than half of an extra £12,000 additional expenditure would have saved her tax at 40% + Student Loan Repayment of 9% = 49%. (The rest of the £12,000 additional cost would have saved tax at only 29%, just like in 2016/17).

In 2018/19, the extra £12,000 expenditure is again reducing Greta’s effective tax bill at a rate of 49%. But, it also reduces her income below the band at which Child Benefit is clawed back – between £50,000 and £60,000 of income.

Within that band, £2,500 of Child Benefit is at stake, which means an effective tax rate of 25% on top of the 49% in effective tax that already applies to her income at that point; an effective tax-saving rate of 74% across most of the £12,000 additional repair costs. Given the very high effective tax in 2018/19 on Greta’s last £12,000 of income, it would make sense to allocate the repair costs in that year. 2018/19 happens to be the current tax year, but it is the overall tax saving that is driving the timing of the expense.

Finally, in the last two tax years to 2020/21, all of the additional expenditure would again save tax at an effective rate of 49%: £12,000 x (40% + 9% Student Loan repayments) = £5,880.

What Does This Prove?

The more complex Greta example demonstrates that, while generally sensible, it is not always the most cost-effective route to claim/incur additional expenses as soon as possible. Landlords should be in a position to estimate how their taxable incomes will start to rise as a result of the new interest relief restriction measures and, having in mind the issues raised in the Potential Traps section above, project when incomes will cross thresholds and be exposed to more punitive tax rates. Timing expenses so as to match incomes exposed to those punitive rates – such as around:

  • the £50,000 - £60,000 income band where Child Benefit starts to be clawed back (assuming one or one’s spouse, etc., is claiming); or
  • the £100,000 income threshold where tax-free Personal Allowance starts to be forfeit.

This – can be very tax-efficient because, as we saw in the Greta example, the rates of tax in these bands can be very high. And it is perhaps worth pointing out that getting this right will not mean just a cash flow benefit but a permanent tax saving.

Of course, it is not always possible to defer expenditure to suit: some repairs or legal costs cannot be postponed. But landlords do often have some choice over when to undertake significant expenditure such as replacing kitchens, bathrooms, etc.

Capital Allowances – Best Of Both Worlds?

Capital Allowances – tax relief for particular types of capital expenditure – are often overlooked in a residential property business because the legislation excludes Allowances on items for use in a dwelling that is being let out in a property business. (CAA 2001 s 35). But this exclusion, although significant, does not prevent relief for:

  • office equipment, furniture, computers, etc., used by the landlord;
  • tools and equipment used for property maintenance or development;
  • cars or vans used in the business; and
  • lifts, security, and safety equipment installed in non-dwelling areas (typically in common areas in an apartment block).

Where available, Capital Allowances can be very useful because the landlord can choose to restrict his or her claim to ensure that only the required amount is used.

Example 2: Capital Allowances – Best Of Both Worlds?

Olly has a substantial and well-established property letting business. He develops his own investment properties and has invested a lot of his funds in machinery and equipment.

Example 2: Capital Allowances – Best Of Both Worlds?

Olly has a substantial and well-established property letting business. He develops his own investment properties and has invested a lot of his funds in machinery and equipment.

Tax Year:

2016/17

2017/18

2018/19

2019/20

2020/21

 

£

£

£

£

£

Income:

 

 

 

 

 

Net Rent after Mortgage

70,000

70,000

70,000

70,000

70,000

Add-back Rental Finance

0

10,000

20,000

30,000

40,000

Total

70,000

80,000

90,000

100,000

110,000

 

 

 

 

 

 

Effective Tax Rate on top slice of income:

40%

40%

40%

40%

60%

 

 

 

 

 

 

                                                                         

Olly knows that when his annual finance costs of £40,000 are fully added back in 2020/21, his income will be pushed into the £100,000+ band and he will start to lose his tax-free Personal Allowance, which means an effective tax rate of 60%. But, that also means that any additional tax-deductible expenditure allowed in that year will save tax at 60%.

As 2020/21 approaches, he intends to buy a new van for £25,000. He knows that he will be able to claim all of that cost against his property business income (assuming non-business use of the van is negligible). Unfortunately, his old van breaks down and he may be forced to buy his new van before the 2020/21 tax year starts. Olly is concerned that he will not get the best tax relief. 

Fortunately, Olly is allowed to defer Capital Allowances if he wants, so in 2019/20, Olly can simply add the cost of the van to his pool of qualifying expenditure and defer making a claim until 2020/21. 

Olly cannot claim the 100% Annual Investment Allowance on the cost of the van if he defers any claim thereon to a later year but, if we assume that Olly has a decent-sized pool of eligible expenditure brought forwards, then he may still be able to set enough standard Writing Down Allowance against his income from 2020/21 onwards, to reduce his income to £100,000 and to save him losing his Personal Allowance – and a lot more tax. Olly’s accountant will be able to help Olly to decide whether claiming 100% relief on the new van in 2019/20 is preferable to spreading the Allowances over several years (but getting more efficient tax relief in the process). It would be better still, if Olly could defer his expenditure eligible for Annual Investment Allowance to 2020/21.

It is also common to restrict Capital Allowances claims where they would effectively be wasted – for example, where income is already covered by the tax-free Personal Allowance, or where losses might otherwise be unutilised (the interaction with property losses and the tax ‘credit’ under the new mortgage interest restriction regime can get quite complex – please see Further Problems With The New Rules, above). 

By Lee Sharpe

This is an excerpt from our popular report How to Beat the Landlord Tax Rises for more information, click here.


This article was first printed in Property Tax Insider in October 2018.

 
Tax Insider Lite

FREE tax strategies delivered to your inbox every month.

  • By clicking on the button below you agree to the terms & conditions and the privacy notice of the website.
  • Subscribe for FREE