What does the freezing of indexation mean for buy-to-let investors? | HK Wealth

What does the freezing of indexation mean for buy-to-let investors?

The Autumn Budget delivered at the end of November included changes to how gains are calculated, including the freezing of ‘indexation’ from January 2018. Indexation is a tax relief which means that gains are currently reduced based on the duration of ownership.What does the freezing of indexation mean for buy-to-let investors?

Due to the severe measures imposed by the government in the last few years on tax reliefs for buy-to-let investors who directly own properties, thousands have moved their properties into company structures. As a result, these buy-to-let investors will now be charged more tax when they eventually decide to sell their properties.

The general rate of corporation tax is used to tax gains by businesses, which includes incorporated landlords. The current corporation tax rate is 19% and is set to fall to 17% by 2020. However, with indexation frozen from January next year, business owners will be unable to offset the effects of inflation, with the estimated cost over the next five years calculated to be £1.8 billion.

The greatest impact is likely to be felt by businesses and landlords who own properties which they have held for a number of years. Whilst the freezing of indexation has been expected by many, it’s possible that the tax relief will be scrapped completely at some point in the future. As such, those in the industry have advised businesses to prepare for this eventuality and make appropriate plans.

For example, a landlord who sold a property in October 2017 for £200,000, which they originally purchased within a company for £120,000 in March 2001, would make an £80,000 gain. The current system allows an ‘indexation allowance’, which is provided by HMRC, to be applied depending on how long the property has been owned for. For the period in question, the allowance is calculated by multiplying the original price of £120,000 by 0.599, which equals £71,880. This is then taken away from the profit of £80,000, leaving £8,120. Corporation tax is then charged on this figure at 19%, which amounts to £1,542.80.

If a property were to be purchased for £120,000 in January 2018 and sold for £200,000 in May 2020 for the same gain of £80,000 but without the indexation allowance, the full amount would be subject to the reduced 17% corporation tax rate for a significantly higher total of £13,600. With this in mind, buy-to-let investors should ensure they are prepared for these higher tax charges when they come into effect.

Sources

http://www.telegraph.co.uk/money/consumer-affairs/budget-2017-buy-to-let-investors-face-higher-taxes-capital-gains/