Pension Freedoms In Action & Losses Revisited

Today is a special day for me as I celebrate a milestone birthday.  Finally I am eligible to buy a warden assisted apartment and settle down to see out what’s left of my days.  I’m thinking that the marketing of these places may need reconsidering and I’m not sure the warden is there for you if you run out of wine at a dinner party!

The other thing I can do from today of course is draw on my pension which seems very strange as I’m still surprised every morning when I look in the mirror and see my hair has gone.

It’s still an open question as to whether the pension reforms which came into force a few years ago may be starting to affect the holiday property market? Over the years I’ve met many owners telling me that their holiday home is their pension, often saying that they didn’t want their money tied up so they couldn’t get at it if they need to and they had no faith in the financial services industry.  Over the years the government has addressed some of these concerns by creating Sipps (self invested personal pensions) where you control how the money is invested and many institutions allow great flexibility in choosing funds but it has always been a defining principle that the only a quarter of the fund could be drawn on retirement, the rest must be used to provide an income.

The 2014 budget produced a huge but very welcome surprise for the industry with George Osborne completely removing the restrictions on taking money out of your pension pot once you are 55 (this age limit will rise over time).  This could mean that in future people will be more inclined to put the money into a pension than buy a holiday home but I suspect that there will be a far greater boost to the market from people either drawing down or anticipating drawdown and using the money to fund a holiday home.

As explained below losses from refurbishment and a high mortgage can be used to produce tax free income with one of the ways this could work being the use of a pension lump sum to clear off the mortgage.  This has been made even more practical with the new arrangements giving lots of flexibility to take income from the property or the pension in the most tax efficient way. The devil is in the detail of course and the lurid headlines about pensioners buying Bugattis all fail to mention the crucial point that withdrawals above the normal 25% will taxed as income, inevitably pushing into the 40% band and maybe into 45%.  Careful planning will be necessary.

Despite the potential negatives I can foresee plenty of people withdrawing large sums to fund holiday property purchases or buying with mortgages to be paid off by a pension withdrawal as it’s an investment you can enjoy and over the last 20 years has probably been as good as any.

It’s been a few years since the major changes in tax rules for furnished holiday lets which removed some of the best tax benefits including the ability to offset losses against other income and get a refund.  This was a fabulous benefit for higher rate taxpayers, particularly those on PAYE with very little opportunity for tax mitigation.

Nowadays losses can only be used against the same business, not even buy to let profit you might have, which means that even if you have no mortgage you are not likely to generate enough profit to use up the losses incurred by any major renovations or in fitting and furnishing a new property.

Of course many of our owners have mortgages which mean that they don’t make much of a profit or even lose money every year before any major expenditure so they are generating losses which can’t be used.

This has not been affected by recent changes as the new rules restricting mortgage interest tax relief do not apply to holiday lets.

These losses are not lost however!  They are carried forward to the next year and continue accumulating forever until you make a profit on the property.  Not much help you might think but actually at some point in the future this could allow you to earn tax free income from the property.

Let’s imagine you bought a property for £400k with a £200k mortgage and spent £60k on renovations and £25k on furnishings and fittings.  Add in mortgage interest other expenses and a limited rental income in the first year due to the work and you could easily end up with a loss of £100k for accounting purposes in the first year.

This figure is carried forward to the next year and further losses are added and carried forward every year until there is a profit.  It’s easy to see a situation where accumulated losses in 10 years time were 150k or more.

The positive way of looking at this is that the first £150k of income from your holiday cottage will be tax free- you may retire and use your pension lump sum to pay off the mortgage, sell another property or just knuckle down with the repayments but once the mortgage is much lower or paid off and as rental income rises profit will follow and you’ll be able to keep all of it, even if you’re a higher rate taxpayer.  This could form part of a retirement plan or fund activities when the kids have left home, as long as you keep the property or own any other holiday let the losses will be there to use forever.

Finally with that in mind don’t forget it’s still worth maximising your losses-

  • Travel expenses – all those business trips to oversee the work at 45p/mile
  • Capital allowance claims on property purchase or subsequent purchases
  • Capital items such as furnishings are written down at 100% nowadays
  • If you can transfer any borrowing to the holiday let from your main home then do so
  • Subsistence – if you are on site for a few days overseeing work then you have to eat!

Please note all this is just general comment and you should speak to your accountant or financial advisor for full information

Simon Tolson owns Rumsey Holiday Homes in Sandbanks and a portfolio of holiday cottage agencies in Cornwall.

Contact Simon on:
t. 01202 707 357
a. 2 Banks Road, Sandbanks, Poole, Dorset BH13 7QD

Leave a Reply