Buy-to-let has seen a revival in recent years with historic low interest rates and increasing house prices that offer landlords attractive rental incomes and capital gains. However, after the recent Budget changes investors are now under threat from impending tax hikes and the increase in stamp duty.
The Government is concerned that first time and young buyers are finding it hard to get on the property ladder with professional landlords getting a competitive edge. In an attempt to “level the playing field” the Government is cutting the amount of tax relief private investors can claim on mortgage interest payments. Currently, landlords can fully deduct mortgage interest costs from their rental income, and only pay the tax on the difference at the highest tax rate they personally pay. This gives the highest rate tax payers an effective rate of relief of up to 45% on their mortgage interest payments.
Under new arrangements due to be rolled out from 2017, private landlords will owe tax on the full value of their rental income (not just the difference between the income and their mortgage interest payments), and by 2020, they will only get a tax credit worth 20% of their mortgage interest payments, which will be deducted from the tax due.
For example, you are a private landlord and have a £150,000 mortgage on a £200,000 property, and a 40% taxpayer. The rental income is £800 a month (£9,600 a year) and the interest on the mortgage is £500 a month (£6,000 a year). Currently, tax is due on £3,600 difference (at 40% or £1,440). By 2020, your client will be taxed on the full £9,600 income (£3,840 at 40%) – minus a 20% tax credit for the mortgage interest (£1,200) meaning a tax bill of £2,640.
How can you potentially side-step the changes?
Private landlords have a number of options to protect their rental income and reduce their tax bill, including:
- Increasing rents to offset a loss in income
- Paying down mortgages (to pay off the mortgage quicker)
- Creating limited companies to manage a portfolio of properties tax efficiently as businesses are unaffected by the changes
Managing properties through a limited company could lead to significant savings: mortgage interest can still be deducted when calculating rental profits, which would be taxed at corporate rates (20%).
Creating limited companies: the pros and cons
Buy-to-let mortgages are typically more expensive, although interest rates are continuing to fall. And although there are costs associated with setting up limited companies and ongoing administration fees, rental income is separate from PAYE salary and can offer substantial tax advantages.
However, clients considering this route will need to ‘sell’ the property to the company, which could result in a capital gains charge for the individual, as well as a stamp duty charge for the new business. Your client might also have to pay an exit charge on their existing mortgages, and there will be costs to the company for transferring the loans.
Clients should understand forming a limited company isn’t suitable for all buy-to-let landlords – it is only an appropriate route for those who own multiple properties and are planning on keeping them over the long-term. It’s essential clients speak to an accountant before making any decisions.
If you are unsure if the changes will affect you or are interested in a Buy to Let property, speak to one of our advisers on 0800 612 8099.