Buy-to-let tax changes: What landlords need to know
Buy-to-let tax changes come into effect from 1 April 2017 and are likely to affect many private landlords
Many individual landlords could face difficulty in trying to make a profit following the Chancellor’s decision in the 2015 Summer Budget to cut mortgage interest tax relief for buy-to-let properties, which comes into force from 1 April 2017.
At the moment these landlords can claim tax relief at the same rate as their income tax banding on mortgage interest payments. From 1 April 2017, a phased reduction will be introduced, ultimately capping interest relief at 20%.
This means that higher and additional rate tax payers will no longer be able to claim 40% or 45% interest relief. The restrictions will be phased in and will be complete by the tax year ending April 2021 as follows:
|Tax Year||Phased Change|
|2017/18||The deduction of allowable finance costs will be restricted to 75%, with 25% being available as a basic rate income tax deduction.|
|2018/19||The deduction of allowable finance costs will be restricted to 50%, with 50% being available as a basic rate income tax deduction.|
|2019/20||The deduction of allowable finance costs will be restricted to 25%, with 75% being available as a basic rate income tax deduction.|
|2020/21||100% of the mortgage interest will be added back to the rental profit and the tax calculated according to the tax bracket the landlord falls into. A deduction of 20% of the interest disallowed will be taken from the tax payable.|
Buy-to-let tax changes: what will the impact be?
The National Landlords Association estimates that more than 400,000 landlords (22 per cent) who pay the basic rate of tax will be forced into a higher tax bracket from April 2017 as a result of these changes.
The Nationwide Building Society published estimated figures of how a typical landlord’s profits might be affected. It illustrated that a landlord with a £150,000 buy-to-let mortgage on a property worth £200,000, with a monthly rent of £800, would currently have a net profit of around £2,160 a year. Under the new system, the net profit would eventually fall to £960.
Other analysts calculate that If you are a higher-rate taxpayer, the new tax will wipe out your returns if your mortgage interest is 75% or more of your rental income.
Buy-to-let tax changes: the company ‘loophole’
The new rules apply to individual landlords only, not limited companies. Setting up a limited company, and placing buy-to-let properties in this company’s ownership would avoid these changes. In order to do this, a landlord would have to sell the property to the company, and this would itself trigger a number of costs, which many well make the benefits of doing this counterproductive, unless the property was to be held for a long period of time.
Selling a buy-to-let property and repurchasing it through a limited company will generate a capital gain if the value of the property has risen since its original purchase. Depending on the rate of income tax paid by a landlord, this will be levied at a minimum of 18 per cent for a basic rate tax payer.
Stamp duty is also payable on the repurchase by the company and since April 2016 all buy-to-let purchases are subject to pay a 3% surcharge on the rate of stamp duty owed. For a property with a purchase price between £250,001 and £925,000 this is 8%.
Any mortgages on properties moved from personal ownership to company ownership may also need to be changed. This can trigger redemption penalties, new product fees and legal and valuation fees. New mortgage rates may also not be as competitive, and lending criteria may differ – all factors to consider.
Other recent changes effecting buy-to-let
The buy-to-let tax changes aren’t the only difference landlords will face, the Chancellor also imposed tighter restrictions on the wear and tear allowance for buy-to-let properties, these already came into effect in April 2016. Landlords had previously been able to automatically deduct 10% of rental profits as wear and tear. Under new legislation they are only able to claim tax relief on costs actually incurred.
Aside from tax, tougher lending criteria for buy-to-let mortgages, set by the Bank of England’s Prudential Regulation Authority, came into effect on 1st January 2017. The new guidance requires lenders to set a more stringent Interest Cover Ratio (ICR) on new borrowing and also apply a stress test, taking into account future interest rate increases. When underwriting new loans, an affordability test will be applied to ensure that rent levels are sufficient to cover mortgage interest and business costs. Under the interest rate stress test, lenders will have to assume the higher of an increase of 2% in buy-to-let mortgage rates, or a rate of 5.5% in the first five years of the mortgage
Stamp Duty increased from 1 April 2016 for purchasers of second homes, which includes buy-to-let properties. For a property purchased at £500,000 (the cost of many two bedroom apartments in London) this change effectively doubles the Stamp Duty from £15,000 to £30,000. A calculator is available on the Government’s website.
The current Stamp Duty bands are as follows:
|Stamp Duty Band||Previous residential stamp duty rates for Second homes||Stamp Duty rates from April 1 2016 for second homes|
|£0 – £125k||0%||3%|
|£250k – £925k||5%||8%|
The future for buy-to-let as personal investments
With interest rates still the lowest they have been for some years, buy-to-let may well remain a feasible proposition and an alternative to savings accounts, ISA’s or bonds, especially in the long term.
Potential landlords looking to invest in buy-to-let for the first time also have the option of setting up a limited company to avoid some of the tax changes, which could help increase profitability. It is often said that buy-to-let is more geared more towards medium and long term investments, and these recent changes seem to reinforce this.
It will be interesting to see how these changes affect the market in the coming years, and how, if at all, the market adapts to take account of these changes.
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