Spotlight on buy-to-let
08-22-2015
While the chancellor’s decision to reduce tax relief on mortgage interest for buy-to-let investors has been greeted with dismay, experts say that it provides an opportunity to re-examine their investments and make any necessary changes. Simon Whittaker, finance director at Mortgages for Business, suggests that while the changes will be a blow to many, they will encourage investors to restructure their portfolios more tax efficiently. For example, he suggests that the tax change has shifted the market in favour of the buy-to-let investment being held in a limited company structure as the new restriction applies to individual investors, not to limited companies.
Of course, there will be initial costs incurred in setting up a limited company in which the portfolio can be held and there are other taxes to consider, such as stamp duty, land tax and capital gains tax. However, the changes mean that for some investors this is likely to work out more tax efficiently than holding the property as an individual. This will become even more pronounced when proposed cuts in corporation tax are implemented in April 2017 and April 2020.
The example in Table 1 assumes that the personal tax allowance is £12,000, the basic-rate tax band £38,000 and the higher-rate band starting at £50,000. Mrs C owns a property worth £250,000 and receives a rent of £17,000 before letting and other costs of £2,000. She has a mortgage of £180,000 with an interest cost of £9,000. Thus profit before rental interest is £15,000 and after interest it is £6,000.
Mrs C might hope that she is not affected by the change since her salary is £43,000, which together with her rental profit of £6,000 leaves her below the higher rate threshold of £50,000. However, the figures show that her tax bill will rise by another £1,600. This is because her gross income, including her rental profit before tax deduction, will be £58,000. Consequently, her additional tax is £8,000 (the total above the higher-rate threshold) x (40% – 20%).
In making his announcement about the changes, George Osborne pointed to the Bank of England’s latest stability report, which suggests growth in the buy-to-let sector poses a threat. This is because buy-to-let borrowers’ loans are more likely to be interest-only and affordability tends to be tested at a lower level than for residential mortgage borrowers. The governor of the Bank of England, Mark Carney, has already signalled a rise in interest rates, possibly at the start of 2016, and there is a fear that landlords hit by higher rates would end up defaulting on their properties in the event they could not afford the rate rise, or sell their properties. That could trigger – or at least aggravate – a fall in house prices.
There are further restrictions on the sector in the pipeline. For example, currently buy-to-let investors can deduct a tax allowance of 10 per cent of the rent from their profit to cover the cost of wear and tear, regardless of whether they spend any money on the property. From April 2016, they will only be able to claim for actual expenditure on the property. Also, the Financial Policy Committee is looking to limit the interest coverage ratio on buy-to-let loans – the percentage of rent compared to the mortgage interest payment.
What about the impact on the private rented sector? There is speculation that buy-to-let landlords will pass their increased costs on to tenants in the form of higher rents. The housing shortage has helped keep prices high and effectively out of the reach of many would be first-time buyers (FTBs). Add to that a shrinking social housing sector and the private rental market is booming. Some critics go as far as to argue that buy-to-let landlords are keeping FTBs off the housing ladder by buying up properties that FTBs would have bought and pushing prices out of their reach.
Mr Whittaker believes the change will have an impact in a number of areas – slowing down the growth in the market and altering its dynamics and structure. He suggests the change is unlikely to put a stop to people using their pension pots to get into buy-to-let since most pensioners will not be paying higher rate or because individuals may choose not to borrow heavily in order to make their purchase. Nevertheless it may deter some, because if they are going to be hit by the new rules they would have to buy and manage the property through a limited company and this added complexity is likely to deter many small investors – “It’s just got a lot more complicated for them,” he says.
As for the idea that buy-to-let investors are likely to panic sell when rates rise and cause a crash, he says he can see no intrinsic reason why buy-to-let investors will be hit that much harder than residential mortgage borrowers. “There will be winners and losers and many people at the periphery will find it painful. But, if they’re not making a good profit now when rates are so low then frankly they probably shouldn’t be in the market.”