Some landlords will suffer financially, in the near future, as Chancellor George Osborne announced in the summer budget that he is reducing tax relief on private rented homes. The relief for mortgage interest, currently enjoyed by landlords, is to be reduced to the basic rate of income tax. The government also aims to crack down on some of the other tax benefits for landlords, which is likely to have a significant impact on the buy-to-let market.
In the UK, buy-to-let homeowners pocketed £112 billion in the year to March 2015, and the average monthly rent has grown by 3.9 per cent on the previous year. The buy-to-let investment route has provided an attractive source of income, as well as capital growth. In 2015, many people have chosen to invest in buy-to-let mortgages and this sector is expected to hold £1 trillion, in the value of properties, in the near future. Property prices are increasing at a steady rate and it is estimated the average house price is now at a record level of £200,000.
Scotland has historically boasted a strong rental market with the average rent reaching £544 per calendar month in May. In particular, Edinburgh has performed well and many property owners benefit from increased rental income during festival season.
Rental income is liable to income tax and will be charged at different rates depending on whether the property owner is a basic, higher or additional rate taxpayer. Next year the Scottish Government will have the power levy a new Scottish rate of Income Tax (SRIT). If this is set at 10p, income tax rates will be the same as the rest of the UK. Setting SRIT above the rate of 10p will increase the tax for buy-to-let owners in Scotland. This may cause Scottish families to be conscious about investing in property, with the potential for increases to income tax.
As for inheritance tax, the government will introduce an additional nil rate band that will supplement the existing nil rate band, currently frozen at £325,000 until April 2021. This potentially allows a combined estate of up to £1m to escape inheritance tax. These changes will be welcomed by families with combined estates worth £650,000-£1m. Unfortunately, this change will not be much comfort to buy-to-let homeowners as the additional nil rate band will only apply to the family home.
There are a number of lifetime estate planning strategies that can be used to ensure that buy-to-let investments are tax efficient. A key aspect is how title to the property is taken. A married couple may decide it would be more tax efficient to hold title to the property in the sole name of either the husband or wife or jointly. Alternatively, there are a number of business structures that can be used and with the potential to make the investment more efficient from a tax perspective or to assist with succession planning generally.
Some buy-to-let owners choose to set up a private trust as a vehicle to hold the buy-to-let property. Trusts can be used to mitigate inheritance tax liability but they also allow some control over the assets to be retained. For example Mr and Mrs Smith could set up a family trust, use the trust to hold the title to a buy-to-let property and the income from the trust could be used to help pay for grandchildren’s school fees.
A final word of caution to those who own residential property in the UK by way of an offshore structure. The UK is going to ensure inheritance tax is assessable on all individuals who own residential property in the UK. These changes target people with non-domiciled status, who use complicated structures to make their UK homes look like offshore assets. Also, from April, non-residents who own UK residential property faced a Capital Gains Tax charge on the disposal of any of their UK property, although they are not resident in the UK. This will come as a shock to many non-residents who have enjoyed relief from capital gains tax when making changes to their UK property portfolios.
With all the changes afoot, property owners may need to tweak the terms of their wills to govern the succession of their estate and seek professional advice on the changing tax landscape. Stating wishes clearly in a professionally drafted can help ensure that any tax payable on the assets that someone owns is kept to a minimum, and ensure proper provision has been made for the succession of those assets. We will have to wait and see how the summer budget changes will influence the wider property market and estate planning generally.
• Peter Shand is a partner at Edinburgh law firm, Murray Beith Murray