Anger among Britain’s two million buy-to-let investors is growing as more of them understand how they are about to be penalised by tax changes currently passing through Parliament.
The complex new arrangements, announced in the summer Budget, will hit only private landlords with mortgages. Companies and cash-rich landlords with no mortgages are left unscathed.
Thousands of middle-class buy-to-let investors – many of whom bought one or two properties as part of their pension planning – have written to their MPs asking for the legislation, part of the Finance Bill 2015-16, to be softened or scrapped. The Bill is awaiting its second reading.
Many landlords are taking other steps. These include raising rents ahead of the changes, paying down mortgages, selling properties or establishing companies as a way to avoid the tax (see Tax change in brief, below).
There is little indication, however, of any change on the part of the Government. And as the Bank of England is currently considering tighter regulation of buy-to-let, many now feel there is too much uncertainty to make further investment attractive.
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The key behind the tax change is the removal of landlords’ ability to deduct mortgage interest from their rental income. This means that although they have to pay interest to their lender, they are taxed as if that cost didn’t exist. This gives rise to the perverse outcome that some will pay tax even when they make a loss.
Tina Riches of accountant Smith & Williamson is one of a growing number of advisers to become expert in the new rules and their numerous, often unexpected consequences.
She explained: “As a guide, once the rules are applied fully from April 2020, if mortgage interest payments are about 75pc of the rent after deducting other costs, a higher-rate taxpaying landlord will find that their tax bill wipes out any profit on the rent.”
Where the increased tax combines with a potential future rise in mortgage interest rates, landlords could be sitting on a “ticking time bomb”, she warned.
Andy Large and his wife, Wendy, own 20 properties in Stoke and Crewe. In this part of the country property prices are comparatively low and flat: their total portfolio is worth £2.5m.
Mrs Large, 46, has been buying to let for 19 years. Mr Large, 41, quit work as an IT consultant in March so he could join her in working full-time on their property business.
The couple have four children, two of whom have cystic fibrosis and require special medical care. The Larges have redeveloped many of their properties and regard themselves as entrepreneurs.
“I’ve been building this business as a legacy for my children and a pension for myself,” Mrs Large said. “My tenants are my clients and I offer them decent, warm, affordable accommodation.”
The new tax, when fully implemented by 2020, would see their income fall by 25pc if other factors, such as mortgage rates and rents, remained the same.
As a result, Mr Large may have to return to his work as a consultant. “This tax has totally thrown us. We have to re-evaluate everything,” he said. They are angry that while investors such as themselves, who own the properties directly, will suffer the new tax, other businesses will not.
“Why is it OK for companies to avoid this tax when we don’t? Why won’t the Government explain its policy? Or is this merely about clobbering an unpopular group of people with higher taxes?” he said.
Cash buyers are also untouched by the tax change, and the Larges believe many non-local cash buyers will come into the market. “Tenant demand is overwhelming here, often from people who do not want to buy. You can buy a two-bedroom property for £75,000 and let it for £475 a month. That’s attractive to cash-rich investors who don’t need mortgages.
“They won’t pay the tax whereas local landlords such as ourselves, committed to servicing tenants, will get hit.”
Other landlords, such as Graham Chilvers, below, make the point that they create many new properties either through building from scratch or conversion – “work that this new tax will almost certainly halt”.
Photo: Jay Williams
What the accountants are advising
Wealthy investors whose buy-to-lets are a small part of their total assets are generally being advised to use other cash to pay down any buy-to-let mortgages, thus avoiding the new tax. They are also being advised to consider rent rises.
“For many, the impact is sufficiently serious for landlords to consider raising the rents they charge,” said Mrs Riches. Where properties are a large source of income for investors – as in the case of the Larges – more radical manoeuvres are being considered. These typically involve establishing companies through which to purchase any future buy-to-lets. Companies can continue to offset mortgage costs, and there can be other tax benefits.
“Finance and other costs can currently be offset against the company’s profits without restriction, but whether this will also change in the future remains to be seen,” Mrs Riches warned.
Moving existing properties into a company structure is also being considered by some landlords, but the stamp duty, capital gains tax and other costs are all potential deterrents.
What the lenders say
Buy-to-let lending is profitable business for Britain’s lenders.
Most lenders are now considering developing new mortgages for landlords who set up as companies. David Whittaker of landlord broker Mortgages for Business said mortgages available to company borrowers currently comprised 13pc of the buy-to-let mortgage range.
“The mortgage market was well prepared for the Chancellor’s grab on landlords’ tax relief,” he said.
He warned that the average interest rate for limited company mortgages was “slightly greater” than for traditional buy-to-let mortgages, although “these rates could come down”.
The outlook for tenants
The new tax has been welcomed by tenant groups and charities, including Shelter, although they have been silent on the likely effect on rents.
Lenders believe rents will rise – if only because the supply of rented property is unlikely to increase as a result of this tax, or even fall.
A senior director at a building society and major buy-to-let lender told Telegraph Money: “It is a matter of market forces. Where a new tax or cost lands on the providers of a service which is already in desperately short supply, there is only ever one result: the cost is passed on to the customers, in this case the tenant.”
Not only would rents rise, he added, “but there is a risk that landlords will invest less in their properties, leading to a fall in the quality of accommodation”.
Tax change in brief
• By 2020 private landlords won’t be able to deduct mortgage interest costs from their rent
• Instead, a tax credit worth 20pc of the mortgage interest will be applied
• All higher-rate taxpaying landlords with mortgages will pay more tax
• Many will see tax bills rise by 100pc or more
• Many will pay tax on zero income or on losses
• Many basic-rate taxpayers will pay higher-rate tax while earning no more income
• Some landlords will lose child benefit or pension tax relief
• While private investors are hit, companies are exempt
• Cash-rich investors who buy without mortgages are unaffected
A worked example: how landlord tax is changing
When George Osborne announced the change, he implied that the extra tax would hit only higher-earning landlords.
It’s true that every mortgaged landlord who pays 40pc or 45pc tax will indeed pay much more under his proposals.
But some basic-rate taxpayers will also pay more tax – because the change will push them into the higher-rate bracket, even though they earn no additional income.
In fact, contrary to Mr Osborne’s suggestion, the only buy-to-let investors who will not be hit are the very wealthy who buy property in cash and who don’t need a mortgage.
At the heart of the change is landlords’ future inability to deduct the cost of their mortgage interest from their rental income.
In other words, tax will be applied to the rent received – rather than what is left of the rent after the mortgage interest has been paid.
Here is a worked example assuming you, the landlord, pay 40pc tax.
Your buy-to-let earns £20,000 a year and the interest-only mortgage costs £13,000 a year. Tax is due on the difference or profit. So you pay tax on £7,000, meaning £2,800 for HMRC and £4,200 for you.
Tax is now due on your full rental income of £20,000, less a tax credit equivalent to basic-rate tax on the interest. So you pay 40pc tax on £20,000 (ie £8,000), less the 20pc credit (20pc of £13,000 = £2,600), meaning £5,400 for HMRC and £1,600 for you. Your tax bill has therefore gone up by 93pc.
Now, say Bank Rate – and in turn your mortgage rate – rises by a small fraction, lifting your mortgage cost to £15,000, while your rent remains at £20,000.
You will have to pay £5,000 tax in this scenario, so you make no profit at all.