Continuing the trend of making changes to the taxation of residential property in recent Budgets the Chancellor today announced three residential property tax changes:
• Limiting the deduction of finance cost in respect of residential property by individual landlords
• Introducing an additional inheritance tax nil-rate band for residential property
• Extending inheritance tax for non-doms to shares in foreign companies which hold UK residential property.
Deduction of finance cost
Individuals are currently entitled to a tax deduction in respect of any interest and other fees paid in respect of loans used to acquire residential property to let to tenants. From 6 April 2017 individual landlords who are higher rate (or additional rate) taxpayers will no longer be entitled to deduct the full amount of such interest and fees.
Between 2017 and 2020 an increasing proportion of the interest and fees will only be deductible at the basic rate of tax (20%) and from April 2020 the whole deduction will be at the basic rate of tax as shown below:
- Tax year 2017-18: 75% fully deductible, 25% limited to basic rate deduction
- Tax year 2018-19: 50% fully deductible, 50% limited to basic rate deduction
- Tax year 2019-20: 25% fully deductible, 75% limited to basic rate deduction
- Tax year 2020-21: 0% fully deductible, 100% limited to basic rate deduction
On the basis that many landlords will use a large proportion of the rental income they receive to pay interest on the mortgage used to acquire the property, this will give rise to significantly higher income tax liabilities. The Government’s impact notice predicts the measure will generate over £600m of additional tax once it fully takes effect in 2020.
There will be no restriction on the deductibility of finance costs for companies holding residential property as an investment and so when combined with the reductions in the corporation tax rate from April 2020 this change may encourage individuals to hold residential property through a company and then seek to extract the proceeds in a tax efficient manner.
Nil-rate band for residential property
As widely publicised prior to the Budget the Government will introduce a £175k additional nil-rate band where a person leaves their main residence to one or more of their direct descendants (broadly, their children, grandchildren and great-grandchildren). The additional nil-rate band will apply in tandem with the existing £325k nil-rate band and so from 2020 will allow a person to leave a property worth £500k (or a property worth at least £175k and other assets) to their children free of inheritance tax.
In the same way as the existing nil-rate band, any additional nil-rate band which is not used will pass to a person’s spouse or civil partner. Accordingly, a married couple or civil partners will be able to leave a £1m house to their children without attracting inheritance tax.
The additional nil-rate band will be phased in over time starting at £100k from April 2017 and increasing each tax year to £175k for the tax year commencing April 2020. However, where a person’s estate is worth more than £2m the additional nil-rate band will be reduced by £1 for every £2 that the estate’s value exceeds £2m. Accordingly, where a person’s estate is worth more than £2.35m they will not benefit from the additional nil-rate band.
Both the amount of the additional nil-rate band and the £2m threshold will increase in line with CPI from April 2021.
Where a person has more than one residence the nil-rate band will only apply to one of the properties; their personal representatives will be entitled to select which residence should benefit from the additional nil-rate band.
The introduction of the additional nil-rate band could discourage people from downsizing and would also discriminate against those who are forced to sell their property in their later years in order to release money to fund their care. The Government plans to introduce rules when the draft legislation is published which preserve the additional nil-rate band for those who have downsized or sold on or after 8 July 2015.
Inheritance tax on shares in foreign companies holding UK residential property
Currently, non-doms do not pay inheritance tax on non-UK assets. Non-doms therefore commonly hold UK residential property through non-UK companies so that no inheritance tax will arise in respect of the value of the property. As discussed in further detail in our blog on the changes to the non-dom regime the Government intends to bring UK residential property owned by non-doms through indirect structures such as companies within the scope of UK inheritance tax. A consultation document will be published in the autumn and it is intended that the changes will take effect from April 2017.