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Buy-to-let: five ways landlords can beat new tax hikes


07-22-2015

 

The removal of mortgage interest tax relief, announced in the Budget and effective from 2017, will hit hundreds of thousands of property investors. Here's what to do

 
'Tax' spelt out in dice
Buy-to-let is looking distinctly less attractive from a tax perspective Photo: © Nick M Do

George Osborne wiped nearly 11pc off the gross returns from buy-tolet properties, leaving many landlords facing the prospect of an annual loss, when he slashed higher-rate relief on mortgages in the Budget.

These losses could balloon further as interest costs rise. The Bank of England Governor, Mark Carney, indicated last week that the first increase was drawing closer.

The tax changes, which begin in 2017, will see landlords lose a quarter of their higher-rate relief each year until 2020, when it will be restricted to 20pc on all mortgage interest.

The National Landlords Association (NLA) has calculated for Telegraph Money that this could reduce typical yields from 4.9pc to 4.3pc for 40pc taxpayers. It could also, for example, convert an annual profit of £612 to a loss of £588 on a typical £160,000 property on which there is a £120,000 loan, according to mortgage broker London & Country.

But if landlords remortgage now, not only will they protect themselves against rising borrowing costs, they may also be able to claw back shortfalls left in the wake of the tax changes. David Hollingworth of L&C said: "As the relief available to higher-rate taxpayers is phased out, it will become all the more important for landlords to be on top of their borrowing costs."

Buy-to-let has proved an increasingly popular tax-efficient investment, delivering steady income and capital growth. As other longterm savings, such as pensions, have disappointed, buy-to-let loans have trebled over the past decade.

Nearly 1.7million tenanted properties have been bought with a mortgage, with the costs offset against rents, bringing tax relief at the borrower's highest rate. This will now be phased out for 40pc and 45pc taxpayers. However, landlords can cancel out the loss of tax relief. We show you how.

1. Remortgage

If a buy-to-let landlord is paying 5pc on a typical £120,000 mortgage, he might currently be earning rental income of £750 per month or £9,000 annually. After allowing for expenses, agents' fees and mortgage interest he is left with a £612 annual profit after tax, according to L&C.

However, when tax relief is reduced to 20pc that profit turns into an annual loss of £588. By remortgaging at, say, 3.79pc with a five-year fixed-rate loan from Virgin Money, he can save £1,452 annually on his interest bill, turning that annual loss back into a profit of £574.

Without remortgaging, his bottom line will deteriorate further as interest rates rise. Should buy-to-let loan rates reach 7pc by the time that higher-rate tax relief has completely disappeared in 2020, he will be looking at an annual loss of £2,784.

So buy-to-let landlords are likely to increasingly seek to peg their losses by fixing their rates longer where possible. Unfortunately, whereas home buyers can borrow at 3pc fixed for 10 years, a comparable 10-year buy-to-let loan will cost nearly 2 percentage points more. One option is from the Mortgage Works at 4.99pc with a £995 fee.

Mr Hollingworth said: "Fixed-rate deals that last more than five years are extremely limited at the moment."

2. Exploit your spouse's personal allowance

Where you do make profits, if your spouse is not working, you may be able to assign part or all of the rental income to them, allowing them to exploit their personal tax allowance, due to rise to £12,500 by 2020, or 20pc tax band.

3. Become a company

The Government is cutting corporation tax to 19pc in 2017 and 18pc in 2020, just as the buy-to-let changes bite. One way for higher-rate taxpayers to cut their tax bills might be to invest via a company. This is not difficult, and can be arranged by your solicitor. But proceed with caution, as there can be complications.

The corporation tax rate isn't the only advantage. All costs can be offset against rental income, so in theory profits may be further improved.

Paul Emery, a property tax partner at PwC, the accountancy firm, said: "If you have £10,000 in rent and £9,000 costs, then tax is only due on £1,000. However, under the personal buy-tolet regime, you could end up with a £4,000 tax bill. Buy-to-let is the only area where you can end up paying tax when you make a loss."

However, income can only be paid out to the directors as a dividend. From next April they can each receive £5,000 annually tax free. After that, dividends paid to higher-rate taxpayers are reduced by 32.5pc, while basic-rate taxpayers pay a 7.5pc dividend tax.

4. Selling property and reducing loans

The changes should prompt landlords to reassess their holdings, with a view to selling up or paying off some of the loan. Ray Boulger of mortgage broker John Charcol said: "Some will take the changes on the chin, while others will wish to reorganise their arrangements.

"Where you have a portfolio, it may make sense to sell one property and reduce the borrowings on others."

5. Raise rents

Many commentators believe rents will have to rise, although how easy that will be given recent sharp upward moves remains to be seen.

Valerie Bannister, head of lettings at LSL/Your Move, said: "There has been a massive shift, with rents climbing faster than property prices. However, we believe there is still further to go, particularly given that landlords have been targeted in the Budget."

The 'accidental' landlords who've done well from rising prices

Brant Thomas, a finance director, became a buy-to-let landlord almost by accident, but is very pleased with the profits so far.

Mr Thomas and his wife, Karen, from Southfields, London, had separate flats before they were married. The equity in the flats allowed them to buy a Victorian terrace house. They also transferred Mr Thomas's mortgage to their home, but rather than sell the flats they decided to keep them and rent them out.

Mr Thomas, 47, said: "The flats have done really well for us, mainly because of the rise in property prices. We've recently sold my wife's flat, but are planning to buy another buy-to-let property."

His own former flat, also in Southfields, has more than doubled in value since he bought it in 2004 for £244,000; it is now worth £570,000, according to a recent valuation. He receives £1,550 a month in rent.

He keeps a close eye on his mortgage costs and has recently remortgaged, on the advice of his broker, London & Country, to a three-year fixed rate with the Post Office charging 2.89pc, cutting his monthly bill from £766 to £696. The loan also carries a £995 fee.

Mr Thomas is relatively relaxed about the changes to tax relief, as the mortgage is well covered by the rent. Furthermore, as his wife is no longer in full-time work, following the birth of their daughter, the couple hope to exploit her tax allowances, not least as she now manages the property.

www.telegraph.co.uk

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