Is Buy to Let Doomed? Not Necessarily.
Recent and planned changes to tax arrangements for second homes and buy to let landlords look set to make the practice much less attractive – at least for higher rate taxpayers.
We have already seen increases to Stamp Duty Land Tax (SDLT) for second homes, where an additional 3% is added to each of the existing rates of SDLT. The removal of the 10% wear and tear allowance on furnished properties was another blow that meant landlords could only claim tax relief on actual costs rather than at a flat rate.
From April 2017 there will be phased changes to the tax relief available on interest charges such that by 2020/21 no mortgage interest can be set against higher rate tax.
The phasing of this change is as follows:
-
in 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction.
-
in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction.
-
in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction.
-
from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction.
What will this mean in practice?
Let’s assume you are a higher rate taxpayer and currently have an unfurnished rental property worth £200,000. From this you generate a rental income of £10,000 per annum. Let’s also assume the mortgage interest is £8,000 per annum. Previously you could offset the mortgage interest (and any other directly related expenses) against the rental income, generating a taxable profit of £2,000. This would then be taxable at 40%, generating a net profit of £1,200.
From 2020, the £8,000 of mortgage interest will not be tax deductible at the higher rate – only at basic rate. Tax will be payable on the whole income less directly related expenses. Assuming there are no other expenses, this would result in tax of £4,000, less 20% relief against the interest of £8,000 (£1,600), resulting in a net tax of £2,400. This turns a £1,200 profit into a loss of £400 (Income of £10,000, less tax of £2,400, less mortgage interest of £8,000).
Buy to let landlords with an existing portfolio will have to make some tough choices. Some are selling up and some are transferring properties to relatives who are basic rate taxpayers. I fear the latter option could be storing up problems with HMRC down the line.
For anyone considering investing in new rental properties the best option may be to do this through a limited company, where corporation tax is 20% and scheduled to fall to 17% in the next 5 years. This may be an attractive option but, as ever, it’s worth getting some professional financial advice first.
Image © Copyright Stephen Craven and licensed for reuse under this Creative Commons Licence
