Updated: May 5, 2018
The government gave landlords a bit of kicking in 2016 with some significant tax changes….
Firstly, mortgage interest tax relief (concentrate!): The vast majority of buy to let landlords with mortgaged properties have what is known as an ‘interest only mortgage’. That means the monthly mortgage payments are just paying off the interest on the loan. So if you borrow £100K over 25 years, your monthly payment might be around £150 but at the end of the 25 years you still owe the bank £100K. The other main type of mortgage, that most owner occupiers have, is ‘repayment’. With a repayment mortgage, if you borrow £100K over 25 years, your monthly payments might be around £300, but at the end of the term your loan is payed off.
Although it can sound scary to some, interest only mortgages do tend to be the sensible choice for most buy to let landlords because they allow you to cash flow better month to month. When you factor is the strong upward trend in house prices over the long term and the positive impact of inflation on the true value of your debt, interest only repayments start to look a whole lot less scary. Still with me? Well done!
Key point: Up until March 2016 it was possible to offset the interest portion of your mortgage payments against your tax bill. From 2016-2020, this is being phased out at a rate of 25% per year. This has a big impact on portfolio landlords with large outstanding loans. Lower rate tax payers will not be affected by the changes, but for those earning more than £46,350 per year with several properties and large loans to value, the impact can be significant.
Everyone’s situation will be slightly different, so it is important to understand exactly how these changes affect you and take the appropriate steps to kerb your tax bill.
So, what can be done I hear you say? Run for the hills? Forget buy to let altogether? No no no…. let’s not be melodramatic here. One option that a lot of investors are taking is to set up a Ltd Company and use that as an investment vehicle. So far, the changes do not impact properties bought through a Ltd company, and as that segment of the lending market grows, Ltd Company mortgage interest rates are improving. Another option for some might be to transfer ownership of existing personally owned properties into a Ltd Company. This can mean incurring capital gains tax and stamp duty charges in the transfer although much of that can be avoided for most. Again, the key is to speak to your accountant and really understand the detail of your own personal circumstance. This is not a one size fits all solution.
Secondly, Stamp Duty Hikes (yikes!): This one is a bit more straight forward to understand. Stamp Duty Land Tax (SDLT) is a tax on buying property or land in the UK. People buying a house to live in pay zero stamp duty for the first £125,000 property value, 2% from 125,000 to £250,000 and then progressively more for each band up to £1.5M, by which point it is 12% on everything over that figure. There is some tax relief available to (non-buy to let) first time buyers.
In April 2016 changes were brought in to increase the stamp duty paid on BTL purchases. The threshold for zero stamp duty was lowered to £40,000, which means all but the lowest value properties will incur some. From £40,000 to £125,000 it’s 3% for BTL purchases. From £125,000 upwards, the BTL rate is 3% on top of whatever the residential rate is. To put this into context the changes have increased the stamp duty tax on a £275k buy to let purchase from £3,750 to £12,000. It is important to fully understand these changes before making any offers to buy a property, because clearly, they will increase the capital needed significantly.
There must be some positives to take from all of this? Well, the tax changes have resulted in a bit of a spike in buy to let Landlords selling up their portfolios. This has meant more suitable BTL properties coming to market which allows the well informed and more professional amongst us to mop up the crumbs and buy those properties.
I don’t necessarily disagree with the government measures outlined above. The market was starting to look a bit over heated in 2016 and this change amongst others, may well contribute to a slight slowing of the market to more sustainable levels. But social conscience aside, landlords with large portfolios in the higher tax bracket who fail to act, will see a significant drop in their post-tax profits in coming years. Likewise, investors failing to understand the stamp duty changes will get a shock when they see the new amount of capital required to get that buy to let investment over the line.