Landlords take the hit as Buy to Let taxation reforms loom

The Chancellor of the Exchequer, George Osborne, has recently announced changes in the taxation of rental properties.

Until now, borrowers with mortgages to finance their rented out properties have been able to offset all the interest charged on their loans against the rental income received from tenants. However, in this year’s summer budget, the Chancellor announced tax reforms to limit the relief to the basic rate of income tax – currently 20 per cent. This ending of upper rate tax relief on buy-to-let mortgage interest payments would end a “huge advantage” enjoyed by landlords, said George Osborne. The reductions are to be phased in progressively over four years, between April 2017 and April 2020.

Some financial commentators have argued that this can be justified as private homebuyers, unlike buy to let investors, are not able to offset any mortgage interest against personal income before calculating personal income tax (MIRAS or mortgage interest relief at source ended years ago). Wealthier investors have even been able to offset at 45 per cent, the higher marginal rate of income tax. This has been a key factor in the popularity of such rentals, resulting in upward pressure on house prices – especially in the south east of England.

The Residential Landlords Association has calculated that these tax reforms will typically reduce rental profit from around £2,150 to just £950 a year for a landlord owning a dwelling worth £200,000, with buy-to-let finance of £150,000. Furthermore, the association is concerned that some landlords may stop using letting agents and choose to manage their own rental administration, in order to make a saving.

Another change will be made to the calculation of taxable income. The allowance for wear and tear on furniture was previously 10 per cent of rental income, with an option to account for actual costs incurred instead. That choice has now been removed, with only actual expenses to be allowed from next April (2016).

While some are mindful that the cumulative effect of the changes will significantly increase the cost of borrowing for richer investors, others are concerned that as a result, many such investors may well decide to sell. This could lead to an undesirable reduction in the number of homes available to new tenants.

Buy to let has been popular with numerous investors over recent years, particularly in times of low interest rates and during periods of volatility on the stock market. Low mortgage interest rates have also influenced this boom in rental properties. However, when viewed on a historical basis, it does seem that mortgage interest rates will have to rise at some point. Although rates have been low over recent years, many lenders charge high fees on buy-to-let mortgages. Even though this fee can be offset against rental income or profit, the money still has to be paid out, reducing income from the property – in some cases by as much as £2,000 in addition to a 25 per cent deposit

Some mortgage brokers consider that the tax measures may encourage ownership to be transferred to limited companies, saving tax because of the continued upper rate relief available to corporate structures on interest payments. On the other hand, there would be tax implications on profits and any future capital gain. Nonetheless, lower corporation tax is being seen as an extra incentive towards an inevitable increase in limited company buy-to-let mortgages.

Finally, those considering buy-to-let schemes are reminded to do their calculations and choose with care. Costs and rental income are clearly key factors to take into account.

If you’re a landlord and would like further information on preparing for the upcoming changes, please call us on 0161 974 0735 or email [email protected]