It’s safe to say the Chancellor won’t be on many landlords’ Christmas card lists this year. Both the 2015 budget, and the most recent Autumn Statement, saw Mr Osborne targeting the buy-to-let sector, making various changes to taxation in the hope of stifling the increase in this market, and creating a more level playing field for first time buyers.
Here’s a summary of the proposed changes, and how they will affect landlords:
1. Reduction in tax relief on mortgage interest costs
This announcement was made in the July budget, and comes into force from 2020. In short, landlords who pay higher rate tax currently benefit from 40% tax relief (or 45% for high rate taxpayers) on any buy-to-let mortgage interest payments. The Chancellor is reducing this to 20%, and transitional arrangements could be phased in from as early as April 2017.
What’s the impact?
As an example, a higher rate tax payer who has rental income of £10,000 and mortgage interest costs of £6,000 would pay £1,600 tax now, but £2,800 under the new rules. Higher rate tax payers whose mortgage costs are 75% or more of the rental income will see their profits vastly reduced.
The reality is that 70% of landlords use mortgage finance to fund their properties, and the average loan-to-value is 54%. So the impact may not be as significant as once thought.
2. Removal of ‘wear and tear’ allowance
Currently landlords can reduce their taxable profits by claiming “wear and tear allowance” equal to 10% of rental income if the property is rented out as furnished. The new rules will see that this relief is restricted to any expenditure that is actually made during the tax year. This may be the costs of repairs or replacing damaged equipment or furniture.
What’s the impact?
Landlords may see the removal of the wear and tear allowance as an annoyance, but depending on the nature and cost of any expenditure, in certain tax years, expenditure may be greater using the alternative method of calculation.
3. Stamp duty surcharge of 3%
From 1 April 2016, stamp duty will rise by three percentage points for landlords and second-home buyers. This change will affect more expensive properties less than cheaper properties as its effect will be proportional.
What’s the impact?
Buying a £250,000 home could cost £7,500 more as a result of the surcharge. Existing landlords are not affected, but those wishing to expand the size of their portfolio will experience the increase in costs. In reality, while this charge will ultimately impact on profit, it’s unlikely to put people off. House price growth over the longer term is likely to see prices rise more than enough to compensate for the extra 3%. Indeed, properties in the UK have increased in value by an average of 6.6% per annum since July 1996. So the extra 3% would have been paid off by the capital growth during the first six months. The average house price increase in London was over 60% over the last five years, meaning that buy-to-lets will remain a very attractive proposition.
The other thing to note is that set up fees, including stamp duty, can be off-set against profits when it is time to sell the property. Therefore there will be less Capital Gains Tax to pay at that time.
4. Capital Gains Tax (CGT)
This is the tax levied on profits from other property rather than an individual’s main residence. This will have to be paid within 30 days of completion of sale from 2019.
What’s the impact?
Currently CGT is payable within 10 and 22 months. Due to electronic returns coming into force, the Chancellor will get his tax due sooner than at present.
In summary:
While the changes are clearly not in the landlord’s favour, they are unlikely to stop the savvy investor. Potential returns on buy-to-let investments continue to look attractive, especially from a capital growth perspective. And as a nation we love property. It’s a tangible investment that offers a good alternative to other forms of long-term financial planning.