After meeting a landlord for coffee this morning we began to discuss the 2015 Summer Budget and Autumn Statement. The Chancellor who we have all grown to dislike introduced several changes that will affect anyone buying or owning a buy-to-let property in the UK. It is important that landlords understand these changes because they may affect the profitability of many buy-to-let portfolios, however small or large they are.
Below is a table summarising these changes
||From April 2016
|Up to £125,000
|£125,000 – £250,000
|£250,000 – £925,000
|£925,000 – £1.5m
From 1 April 2016, higher rates of Stamp Duty Land Tax (SDLT) (3% above the current rates) will be charged on the purchase of additional UK residential properties. This means in derby where majority of buy to let investments which were under £125,000 that were attracting no stamp duty will have a 3% SDLT added to it. Terraced houses are the largest percentage of types properties purchased to let in derby, in 2015 the average value of terraced properties sold in derby was £115,000 approximately, these investments had no SDLT, but after April this year you will have to fund an extra £3450 on average to make this purchase in the future.
For example, a property bought now for £500,000 would attract an SDLT rate of 5% or £25,000. But after 1 April it will be 8% or £40,000 if the purchaser already owns one or more UK residential properties.
Also, from 2017 the amount that some landlords can claim in tax relief on their finance costs (such as mortgage interest payments, interest on loans to buy furnishings and fees incurred on taking out and repaying mortgages) is being gradually reduced over 4 years.
When the new restrictions are fully in force from the beginning of the 2020/21 tax year, landlords will be only be able to claim tax relief at the basic tax rate of 20%, instead of 40% or 45% for those in higher or top rate income tax brackets respectively.
How the current rules work
At the moment, you can claim all of the annual mortgage interest you pay against your income from a property, and then only pay tax on the difference. So if your income tax rate is 40% then your tax bill is 40% of this difference.
Here’s an example. Let’s say your buy-to-let property generates a rental income of £10,000 a year, while you pay £9,000 interest on your annual mortgage payments. At the moment, you only pay income tax on the £1,000 difference between the rental income and the mortgage interest.
If you pay the basic rate of tax (20%), you’ll owe £200. Those who pay the higher rate of tax (40%) will owe £400, and if you pay the top tax rate of 45%, it would be £450. In another example, if you receive £15,000 in rent annually and pay mortgage interest payments of £10,000 a year, a basic-rate taxpayer will owe £1,000 under the current rules, while a higher-rate taxpayer will owe £2,000 and a top-rate taxpayer would owe £2,250. These examples assume there are no other deductible expenses for tax purposes.
The new rules explained
From 2017, the way the tax relief is calculated is going to change. Under the new rules, you will owe tax at your personal tax rate on the entire income from a property. From 2020/21, when the rules are fully in force, you will only be able to deduct a maximum of 20% of your mortgage interest payments from this tax liability to calculate the amount of tax due.
This means that if you pay income tax at the basic rate of 20%, you won’t see any change in the amount you owe.
Imagine that your buy-to-let property generates a rental income of £10,000 a year with mortgage interest paid of £9,000. In 2020, when the new rules are introduced in full, you will be taxed at 20% of £10,000 (or £2,000). Then 20% of your £9,000 mortgage interest payments (or £1,800) can be deducted, leaving you with a tax bill of £200, the same as before.
But higher and top-rate taxpayers will pay more. Based on the same scenario, in 2020, higher-rate taxpayers will be taxed at 40% of £10,000 (or £4,000), but will only be able to deduct 20% of their £9,000 mortgage interest payments (or £1,800).
This will leave higher-rate taxpayers with a tax bill of £2,200, compared to £400 under the current system. Those paying the 45% tax rate will owe £2,700, compared to £450 today.
Looking at the example where the annual rent received is £15,000 and mortgage interest payments are £10,000 a year, basic-rate taxpayers would still owe £1,000 under the new rules, the same as before. However, higher-rate taxpayers will owe £4,000 from 2020, compared to £2,000 under current rules, and top-rate taxpayers will owe £4,750, rather than £2,250.
So as landlords around derby are searching for answers, I have a few suggestions, what probably won’t work is simply hiking up your rents to compensate, as most tenants are already paying as much as they can afford. If you think you might be affected, there are a few other things you can try:
- You could switch to shorter-term fixed rate deals to get lower rates of interest, although these mortgages carry more risk.
- You could place your property portfolio in a limited company structure. You would then pay corporation tax (which is lower) rather than income tax on your profits. A drawback is that your mortgage options will narrow as fewer providers will lend to a company. However I predict these options will open up as most portfolio landlords will turn to this method.
- If your spouse pays a lower rate of tax, you could transfer ownership of one or more properties to them (taking care this does not lift them into a higher tax band).
As with most clouds, there is a silver lining. If you’re a landlord with a lower income, you’re no longer at such a disadvantage to those in the big league. This level playing field may in fact help the new wave of ‘silver landlords’ hoping to use their pension pots to buy rental property. Also, if you’re a homebuyer, you may find prices becoming more affordable as the competition from buy-to-let decreases.
Overall, landlords I can’t emphasise enough how important it is to do your research, and to speak to professionals around you for simple advise. It is important to do the math before you begin to search for a property to invest in. As always I’m here to discuss this or any other subject with you, you could either call or email me, or simply follow us at the derby city property blog to stay informed.
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