beat the tax changes

A clever married couple refinanced their property portfolio to beat the tax changes, proving that the most profitable restructure is not always a tax restructure.

Many landlords have restructured their property portfolio to protect against tax changes over the last 6 years. However, not every restructure has involved a change of how property profits are taxed.

Indeed many landlords are making more money now – having made no change to how they account for their profits – and despite the tax changes.

At Less Tax 4 Landlords we have a saying “Don’t let the tax tail wag the planning dog” and this example I gave at the Landlord Investment Show in London recently is a good example.

We looked at a married couple, who had a £4 million portfolio, with £2 million in mortgages.

It is 2015, so before Section 24, and the portfolio is financed at a 4% interest rate (or £80,000 in annual interest payments).

With a 6% gross rental yield, they are taking £240,000 in rent each year. £48,000 (20%) of this is then spent on tax-deductible expenses. Pay the £80,000 interest and there is £112,000 left in the bank before tax.

2015 – Before Section 24
Annual Rental Income £240,000
£2 million BTL mortgage at 4% interest £80,000
Other Tax-Deductible Expenses £48,000
‘Real’ Profit £112,000
Taxable Profit £112,000

It’s before Section 24, so the finance expenses are still fully tax-deductible. Meaning there are £112,000 of profits to pay tax on. As the portfolio is shared equally by two people, they will pay tax on £56,000 each – and are higher rate tax-payers.

Now fast forward to 2021, and Section 24 is fully in effect and interest is no longer tax-deductible, but we can claim 20% of our finance costs as a deduction against tax.

Since 2015, our Landlords have done very well, taking advantage of exceptionally low rates and refinanced their portfolio at 2%. By keeping their mortgages at £2 million, their interest payments have halved to £40,000.

With loyal tenants, they have forgone any rent increases so we still have £240,000 income. They have managed to keep spending to the same £48,000 tax-deductible expenses, meaning that after their £40,000 of mortgage interest, they have £152,000 left in the bank before tax.

Or in other words, compared to 2016 they have an extra £40,000 in the bank before they pay their taxes.

However – because of Section 24, they cannot deduct the £40,000 mortgage finance as a tax-deductible expense, and so are actually taxed on £192,000 – an increase of £80,000 since 2016.

2021 – After Section 24 Change vs 2015
Annual Rental Income £240,000
£2 million BTL mortgage at 2% interest £40,000 Down £40,000
Tax-Deductible Expenses £48,000
‘Real’ Profit £152,000 Up £40,000
Taxable Profit £192,000 Up £80,000

 

Based on a 2 person unincorporated partnership, that extra £80,000 will be taxed at 40%. That’s an extra £32,000 in tax. However, we also get a 20% tax credit on our £40,000 of interest. So that’s a deduction of £8,000. Meaning our final tax bill has increased by £24,000.

But we have an extra £40,000 in the bank. So our after-tax income is up £16,000 or £8,000 each.

You can see then why it’s been profitable for many landlords to grow their portfolios through greater borrowing even with the tax changes.

With mortgage rates so low – many landlords have remortgaged, will be seeing strong cashflow, despite the extra tax payments, and the extra tax can be easily offset by switching to a mortgage with a lower rate.

It is also why some landlords are sitting on the fence about restructuring their business from a tax perspective because they have been able to restructure from a finance perspective, and still be better off than they were, before the tax changes.

Of course, I write now after 12 years of record low and decreasing interest rates.

And as interest rates rise, every £1 of tax saving will count for more.

Landlords paying 40% tax or more on their property profit, mortgaged or not – are probably paying more tax than necessary.

If you’re in this position, then I recommend taking our initial assessment – it’s free, and could save you £000s to reinvest in your property business.

 

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