Let’s examine the changes to buy-to-let taxation imposed by former Chancellor George Osborne and, crucially, how they could affect your finances.
Stamp duty increase
Everyone who buys a property pays stamp duty land tax (SDLT) at a fixed percentage of the property purchase price. Stamp duty rates start at zero for properties worth less than £125K and rise to 12% for properties worth more than £1.5 million.
So, on a two-bedroom flat worth £275,000, you’d pay £3,750.
Except if you’re a landlord.
As of April 1 last year, landlordshave to pay a stamp duty surcharge of 3% when they buy any additional properties worth £40,000 or more in England, Wales or Northern Ireland.
Just to be clear, that’s not 3% more stamp duty (as reported in many newspapers) but an additional 3% charge.
So, on the same two-bedroom property worth £275K, a landlord would pay £12,000. That’s £8,250 more than an owner-occupier.
Stamp Duty Rates
Band Normal Rate Additional property rate Less than £125k 0% 3% Next £125k – £250k 2% 5% Next £250k – £925k 5% 8% Next £925k – £1.5m 10% 13% Rest over £1.5m 12% 15%
Click here for an SDLT calculator to calculate how much you’ll have to pay.
Who will it affect?
The additional stamp duty will apply to everyone who already owns at least one property in the UK or elsewhere. The rate applies whether you are buying an additional property as a rental investment, a second home or to let as a holiday home.
It will also apply if you buy an additional property jointly with someone who doesn’t own another property, including your partner or child.
You can get a refund of the additional stamp duty on a second property as long as you sell your first property within 3 years of buying the second, so you could let the second property for up to 3 years and still get a refund of the additional SDLT.
If you buy a property for a child and place it in trust, you won’t have to pay the additional stamp duty.
If you own more than one property and you sell your main residence, you won’t have to pay the additional SDLT when you buy a new home, as long as this is within 3 years of the sale.
Likely impact of the stamp duty increase?
Obviously the increase in SDLT for landlords will add a substantial amount to the property start-up costs, reducing its appeal when compared to other forms of investment (such as pension funds, which attract tax relief).
The additional stamp duty will mean that you’ll need greater house price inflation to recover your initial outlay, which will mean hanging on to your rental property for longer.
If you need to borrow additional funds to cover the extra stamp duty, you’ll need to earn more rent to cover your higher interest payments.
However, the rise in stamp duty might not necessarily be bad news for those landlords looking to buy. It could lead to a fall in property prices as the increase in SDLT might put off some investors, making the market less competitive. Some investors simply won’t be able to scrape together the additional cash needed for the stamp duty in addition to the deposit.
Latest market research suggests that there are already far fewer landlords looking to buy now than there were a year ago.
If growth of the private rental sector slows down, it could lead to a shortage of rental properties, which could mean fewer and shorter voids for the rest of us. A shortage of rental properties could lead to rising rents.
On the other hand, if less competition in the housing market does lead to lower prices, more people might be able to afford their own homes, leading to a fall in the numbers renting and a corresponding drop in rents.
In short, we will have to wait and see.
Loss of mortgage interest tax relief
At the moment, a landlord pays tax on their rental income minus any mortgage interest payments and other costs such as letting agency fees and repair bills.
From April 2017, landlords will be taxed on their income BEFORE they have deducted their mortgage interest payments.
They will then receive a tax credit for the interest, but this will be gradually reduced for higher tax payers from 35% next year down to the basic rate of tax, which is currently 20%, by 2020.
Who will it affect?
The Chancellor claimed that swapping mortgage interest tax relief for a less generous tax credit would only hit higher rate tax payers, in other words, the wealthier landlords, but this isn’t true.
Landlords who are currently lower rate tax payers could be bumped into the 40% tax band because their rental income will be added to any other income BEFORE they’ve deducted their interest payments.
So, if you earn £35,000 plus £10,000 rental income and pay £5,000 interest on your buy-to-let mortgage, your total taxable income today is £40,000 (£45,000 – £5,000), but from April 2017 it will be £45,000, tipping you into the 40% tax bracket.
Not only will it mean that many landlords will pay tax at a higher rate than previously, but they might also lose credits such as child benefit.
Landlords with large buy-to-let mortgages and low yields could end up making a loss if and when interest rates rise, but they’ll still have to pay tax on their rental income, even if they aren’t making any profit.
In other words, many of us run the risk of being taxed on a loss.
Obviously it won’t impact on landlords without mortgages (including Prime Minister David Cameron who is letting his mortgage-free North Kensington home while living at 10 Downing Street).
Yes. Companies that own residential rental properties can continue to claim mortgage interest tax relief as a normal business cost after April 2017.
This means that it might be worth setting up a company if you’re thinking of investing in rental property.
It might also be worth incorporating your existing rental properties, but if you do so you will incur other taxes. As you’d effectively be selling your rental property to your company, you will have to pay capital gains tax on any increase in its value above your tax-free allowance (currently £11,100 per person) since you bought the property, plus the company would have to pay stamp duty at the new higher rates (see above) to ‘buy’ the property from you.
If you are considering setting up a company, you should take some advice from a property tax expert.
Likely impact of the loss of mortgage interest tax relief?
It’s possible than landlords with high loan-to-value BTL mortgages will start to exit the market when these changes hit home. This might lead to a fall in house prices, but when property prices come down, rents tend to see-saw upwards.
Many landlords are already talking of pushing up rents now to cover their higher tax bills from 2017, but it remains to be seen whether they can make these higher rates stick. You can only charge what people can afford to pay and in some cities they might already have reached a ceiling so landlords will have to wait for salaries to rise before they can push them any higher.
Loss of landlord wear and tear allowance
It used to be that landlords who offered furnished accommodation could automatically deduct 10% of their rental income from their taxable profit to cover the cost of replacing items of furniture, even if they hadn’t actually replaced any furniture at all.
Sadly, not any longer.
The 10% wear and tear allowance was withdrawn last April.
Instead, landlords can deduct from their tax any money they’ve spent replacing worn out, damaged or missing furniture. Note that furnishing a property at the outset isn’t tax-deductible, landlords can only claim back the cost of replacing furniture.
Who will it affect?
All landlords who furnished their rentals who previously claimed the 10% wear and tear allowance rather than claiming tax refunds for replacement items (they previously had a choice).
As there’s no longer any tax advantage to letting furnished accommodation, if you can get away with letting a property empty, there’s really no point spending money furnishing it.
Therefore, we are likely to see a fall in the number of furnished rentals coming on to the market.
However, if this happens, some landlords who continue to provide furnished accommodation might see this as an opportunity to push up the rent.