reducing tax on rental income

Lannister_2

Hello,

I'm currently renting out my former home and after mortgage + expenses I'm making a loss.

My wife is not working, staying at home with the kids and has no income apart from tax credits.

The mortgage will soon be paid off and I'll be about £8k a year better off (after expenses).

Once this is declared to HMRC I'm looking at the loss of all of our tax credits and a £1,600 tax bill. What's the best way of reducing these losses? I've heard about a few options..

1) Split the rental income between myself and my wife so we can benefit from her (unused) tax free allowance. I understand that the default ratio is 50-50 so this would reduce my tax bill by half but still cause us to lose our tax credits.

I understand I can make a declaration of trust to allocate 99% of the beneficial interest to my wife and then send a form 17 to HMRC to confirm this arrangement. As this income will be under the tax free allowance then there should be no tax payable. Is this correct? Does anyone have any experience of this process? Obviously as tax credits is based on joint income then they are still out of the window.

2) Setting up a private company and running the rental through that. I'm not particularly au fait with the ramifications of this. All I do know is that the 20% corporation tax paid would be less that the loss of all our our tax credits. My eventual plan is to save the rental income from this property until I have enough to buy a second property to retire to. I'll then use the rental income to top up my rather meagre pension. What could be the drawbacks of this plan?

I would appreciate any advice or comments. Thanks for your time.

princeofpounds

First of all, are you making use of all your allowable deductions for expenses?

http://www.direct.gov.uk/en/moneytaxandbenefits/taxes/taxonpropertyandrentalincome/dg_10014027

Secondly, is it actually the wisest thing to pay off the mortgage on the property? Keeping it mortgaged can give you interest tax relief.

http://www.thisismoney.co.uk/money/mortgageshome/article-1585128/Tax-buy-let-pay-less.html

00ec25

Lannister wrote: »

I understand I can make a declaration of trust to allocate 99% of the beneficial interest to my wife and then send a form 17 to HMRC to confirm this arrangement. As this income will be under the tax free allowance then there should be no tax payable. Is this correct? .

correct

however make sure you do not compromise the CGT exposure of the property by transferring it incorrectly to your wife - ie keep it benefical shre of income not actual share of ownership
IF you and only you have an entitlement to private residence relief on the proeprty then if she never lived in it she cannot acquire those rights from you if you do a physical transfer of ownership so you would lose a large chunck of CGT relief.
Of course if you don't have PRR rights yourself anyway this is irrelevant!

Lannister wrote: »

2) Setting up a private company and running the rental through that.

Lannister wrote: »

.

generally people advise against doing this if you only have one property under rental as the costs (£ and admin time) in operating a company are counter productive

Thrugelmir

How are you repaying the mortgage?

Lannister_2

Thanks for the speedy responses. Apologies for sloppy formating as I can't post links.

“First of all, are you making useof all your allowable deductions for expenses?”

Yes. The mortgage is by far thebiggest expense, Maintenance contracts and insurance make up perhaps 10% of therental yield.

“Secondly, is it actually thewisest thing to pay off the mortgage on the property? Keeping it mortgaged cangive you interest tax relief.”

I don’t think so in my case. At the moment I’mpaying £550 pm on a mortgage at 6% interest (got stung on a fixed rate 3 ½ yearsago, who knew?). Surely it would be more efficient for me to take the tax hitof 20% of the rent (approx. £100) and put the other £450 pm away to gain atleast 3% interest on it? The property I currently live in is rented so I onlyhave one mortgage. Unless I’m missing something?

“correct

however make sure you do not compromise the CGT exposure of the property bytransferring it incorrectly to your wife - ie keep it benefical shre of incomenot actual share of ownership
IF you and only you have an entitlement to private residence relief onthe proeprty then if she never lived in it she cannot acquire those rights fromyou if you do a physical transfer of ownership so you would lose a large chunckof CGT relief.
Of course if you don't have PRR rights yourself anyway this is irrelevant!”

We both lived in the property for two yearsbefore moving out and renting.

I don’t ever intend to sell the home, just torent it out forever and live off the rental income in retirement then leave itto the kids – does this mean no CGT is payable or would this have to be paidupon transferring the beneficial share?

I do have a limited understanding of theseterms and I’m aware that it’s a beneficial share of the property that needs tobe changed not actual share of ownership, which should remain at 50-50. On thesubject of the transfer… Is it all above board to do this? Does HMRC requirethat formal arrangements for the paying of bills and receipt of monies are putinto place? At the moment the rental income goes into a joint account that themortgage and other household bills are paid from, my wife and I then pay intothis separately to cover the costs. If I’m declaring that my wife is now the99% beneficiary of the rental income, would I have to demonstrate that she isliable for that share of the costs and pay the money direct to her?

“How are you repaying the mortgage?”

Bog-standard residential mortgage. We didn’tintend to be landlords, we took a residential mortgage for our home and livedthere for two years. Then I joined the forces and was promptly posted to theother side of the country. Due to negative equity and the extortionate earlyrelease charges we decided to rent out. The bank agreed and grantedconsent-to-lease. That’s nearly paid off now (I’ve had a VERY thrifty fewyears) and a family member is helping us with the remaining few quid once our currentfixed term ends in a few months.

Werdnal

Are you taking all the mortgage payment as an expense against your tax? HMRC only allow you to use the interest portion, so any repayment is not a permitted expense. How have you been calculating it?

HappyMJ

Werdnal wrote: »

Are you taking all the mortgage payment as an expense against your tax? HMRC only allow you to use the interest portion, so any repayment is not a permitted expense. How have you been calculating it?

That was what I first thought when OP said the mortgage will soon be paid off. At £550 a month and 6% interest that would imply that £110,000 was still outstanding. Then they say a family member will be helping with the remaining last few quid...to me a few quid is maybe £5,000 certainly not £110,000.

My choice is to pay only the interest on the mortgage saving as much as possible into ISA's in both your names to maximize tax free income as much as possible leaving the full amount of the mortgage outstanding. 6% for a BTL isn't terribly high.

princeofpounds

I don’t think so in my case. At the moment I’mpaying £550 pm on a mortgage at 6% interest (got stung on a fixed rate 3 ½ yearsago, who knew?). Surely it would be more efficient for me to take the tax hitof 20% of the rent (approx. £100) and put the other £450 pm away to gain atleast 3% interest on it? The property I currently live in is rented so I onlyhave one mortgage. Unless I’m missing something?

If you got a new mortgage, variable or with a short fixed term, and at a low LTV then it will be far cheaper than 6%! Just make sure it has a flexible repayment facility and that you invest the money raised in something liquid and low risk.

I'm not telling you this is your best option - that requires some calculations on all possible scenarios - but it it one way of providing creating a tax shield.