Thousands of buy-to-let landlords are in for a shock when they get their tax bills for the 2017/18 financial year. In what has widely been described as an ‘assault’ on landlords, the government is gradually phasing out the 100 percent tax relief on mortgage interest and other finance costs that landlords previously enjoyed.
Between April 2017 and April 2020, the 100 percent tax relief on mortgage interest will fall to 75 percent, then 50 percent, then 25 percent and finally zero. Once the relief hits zero, it will be replaced with a 20 percent tax credit that is applied to the taxable profits that landlords make on their properties.
Who will it affect?
Landlords who are in the higher and additional rate tax brackets – perhaps because they are in employment, have a very profitable property business or earn income from other sources – will suffer the most pain since they are waving farewell to tax relief at 40 percent and 45 percent.
But basic taxpayers may also be affected because as those with income close to the threshold could find that they have been dragged into the higher-rate tax bracket as a result.
The landlords who are likely to get the biggest surprise, however, are those who have no knowledge at all of the changes that came in with Section 24 of the Finance Act 2015. Research undertaken in March 2017 by referencing service Tenant Referencing UK suggested that as many as 1.4 million landlords were unaware of Section 24 and what it would mean for their rental profits.
Vik Tara, a landlord, letting agency owner and chief technology officer of proptech consultancy PropCo, says: “Many buy-to-let landlords are heavily geared and, if they haven’t planned for, or are unaware of, the changes, then the increase in tax could run their portfolio into unexpected losses.”
What are some landlords doing to mitigate the effect?
Some landlords are selling properties as part of a strategy to reduce their gearing. Typically they are divesting properties with the lowest yields in order to pay down debt on other investments. A survey by the NLA, published in January, found that 20 percent of its members plan to reduce the number of properties in their portfolio during the course of 2018 – the highest level of intended property sales in 10 years.
Research by estate agency and property services group Countrywide also shows that landlords are offloading properties, particularly in expensive areas. Significantly, the number of homes on the rental market in London tumbled by 21 percent year-on-year in 2017.
What are the options for landlords?
One way landlords can potentially mitigate the impact of the Section 24 clauses is by incorporating their property business – that is, setting up a company and transferring the ownership of their properties to the company. This could trigger upfront capital gains and stamp duty land tax charges, however, which is why there is more of a trend for landlords to buy new homes in a company than to move existing properties into a corporate envelope.
Ian Naylor, a partner at Staffordshire solicitor firm Bowcock & Pursaill, which specialises in tax planning, also points out that, while transferring property interests into a limited company could be a way for landlords to ease their tax burden, it is not so straightforward for them to draw capital from the company in future. “It also comes with the burden of more reporting paperwork, such as the preparation of annual accounts,” he adds.
The reality is that it is still early days in terms of assessing the impact of the Section 24 changes on landlords’ behaviour and the rental market more broadly. Nevertheless, the full impact, when it comes, could be significant not only for landlords, but also tenants, which is why the NLA is lobbying the government for a policy rethink.
What’s the NLA view?
Taxing Homes, a 2017 report commissioned by the NLA and prepared by Capital Economics, predicts that the average buy-to-let property would be £850 per year less profitable once the Section 24 policy is fully implemented, with landlords clawing back 50 percent of that loss through rent rises. Rents could be pushed up by seven percent nationally over four years – the equivalent of £250 a year. The report also estimates that buy-to-let-backed private-rented-sector stock could fall by 46,000 properties by 2020/21, with landlords deleveraging by almost £8bn. Ultimately, it might not be landlords who get the biggest shock from Section 24, but the UK economy as a whole.
To download the Capital Economics report and to find out more about the impact of the Section 24 changes on landlords, see: www.taxinghomes.co.uk
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