The UK Budget's rise in property income tax, combined with the continued freeze on income tax thresholds, will significantly tighten margins for landlords – especially those already strained by rising costs and restricted mortgage interest relief. This article considers the impact and possible next steps.

The following article about the recently-announced rise in property income tax rates in the UK, comes from Caroline Foulger (pictured below), a partner at Partners Law. She has been published in these pages before.

Caroline Foulger

The Autumn Budget of 26 November certainly drew critical responses from the wealth management sector. As is the way with such matters, more details have emerged about exactly how particular tax changes will affect people. For those advisors needing to keep on top of such issues, this article will hopefully provide useful guidance. 

The editors are pleased to share such ideas, and the usual editorial disclaimers apply. To comment, email tom.burroughes@wealthbriefing.com and amanda.cheesley@clearviewpublishing.com
 

The upcoming 2 per cent rise in property income tax rates, effective from April 2027, marks a significant development for property owners and investors. This additional cost could prove pivotal, potentially prompting some property owners to reconsider their strategies, such as incorporating or exiting the market entirely in favour of alternative investments. Others may see this as an opportune time to re-evaluate broader estate planning considerations.

Recent years have seen numerous incremental changes within the sector, making residential property investment increasingly challenging:

-- Since April 2020, mortgage interest is no longer fully deductible; instead, landlords receive a 20 per cent tax credit on interest incurred. For highly leveraged landlords, this has had a considerable effect on profitability.

-- Mortgage interest rates have been elevated since Autumn 2022. Although current rates are now below 4 per cent, landlords transitioning from three- or five-year fixed-rate deals continue to experience the impact of higher borrowing costs.

-- The introduction of Making Tax Digital (MTD) for income tax self-assessment (ITSA) will require landlords with rental incomes exceeding certain thresholds (£50,000 ($67,137) or more from April 2026; £30,000+ from April 2027) to submit quarterly updates rather than annual returns. Notably, MTD thresholds apply to combined rental and self-employed income, excluding employment, pension, dividend, and savings income. This added administrative burden may prompt some landlords to reassess their choice on incorporation as this may be an equally onerous option.

-- The abolition of the Furnished Holiday Let (FHL) scheme in April 2025 resulted in the loss of full interest deduction for income tax, capital allowances, and Business Asset Disposal Relief (BADR) for capital gains ax (CGT).

-- Rental reforms taking effect from May 2026 are poised to introduce further complexity. All tenancies will transition to rolling assured periodic agreements, continuing month-to-month until terminated by either the tenant (with two months’ notice) or the landlord (subject to a Section 8 notice with appropriate grounds). Notice periods may extend, such as four months when selling or four weeks for rental arrears. Landlords, who will be restricted to collecting only one month’s rent in advance, can raise rent only once per year with two months' notice, and tenants will be entitled to challenge increases at a tribunal. 

Additionally, landlords cannot refuse applicants based on children or benefit status and must provide a written response within 28 days if refusing a statutory request for pets, citing reasonable grounds.

-- Many rental properties, particularly flats in London and the South East, have experienced stagnant or declining prices in recent years. Consequently, property may no longer offer the same capital appreciation previously enjoyed, affecting its overall attractiveness as an investment asset.

Recommendations you may want to consider for residential landlords remaining in the sector:

-- Undertake rent reviews where possible before May 2026, accounting for anticipated expenses coming down the line 2027, given forthcoming legislative constraints on rental increases.

-- Price all new tenancies with consideration of impending rule and tax changes, as well as potential adjustments to mortgage interest rates for those nearing the end of fixed-term arrangements.

-- Invest strategically in property improvements to command premium rents, attract high-quality tenants, and prepare for the mandatory EPC rating of C by 2030.

-- Prepare for MTD by sourcing suitable accounting software and implementing robust expense tracking systems to minimise future tax administration costs.

-- Revisit the prospect of incorporation, especially in light of the revised tax regime and MTD requirements. Where possible, explore transitioning into partnerships to maximise CGT reliefs, with timely action ahead of April 2027 deadlines.

-- Is now the right time to incorporate and bring the next generation in as shareholders, as part of estate planning?

-- If not incorporating is now a good time to look at a partnership or joint ownership with the next generation as part of wider estate planning?

-- If they are not opposed to gifting, is looking at a gift to discretionary trust worth looking at, even if the property value exceeds the nil rate band, gifting a portion to a trust may have long-term benefits for inheritance tax (IHT) planning in terms of a joint ownership valuation discount in future and passing a portion of the income to others. Obviously, this is more challenging where properties are subject to mortgage.

-- Look at consolidating property numbers to have fewer, better quality, mortgage-free properties and reduce the risks of having more tenants to manage and more compliance.

-- For those who were in the FHL regime look at whether it is feasible to turn these into bed and breakfasts, it might be for substantial properties in areas where employment is low but tourism is high.

For those who have decided to exit the sector to some extent or entirely then consider with them a full estate planning review in terms of: 

-- The net funds likely to be generated by sales after capital gains tax, legal costs and other expenses such as early repayment charges on mortgages.

-- The reduction in net income and whether this needs to be replaced, and the options for that.

-- Whether capital growth is better in light of the lower tax rate, whilst being mindful of whether regular gifts from surplus income would be a good exemption to utilities so a focus on income is preferable despite the income tax rates.

-- If there is regular gifting already (for example paying for childcare or education costs for grandchildren) does this need to continue from income, could it be from capital, would a bare trust for each of them work? Or is a discretionary trust to benefit all of them an option?

The changes coming in for taxation of rental income may be the trigger needed to look at full estate planning with your clients. Whether that is a review of incorporation and looking at bringing in other family members into the “business” or exiting completely and how to invest next. 

You should be alive to all the options and be challenging your client to be open to possibilities – not that easy when they have been landlords for 20-plus years and like the stability of property, but it is likely to be worth the effort for them and you in the longer term.