Buy To Let Tax Grab

George Osbourne’s 2015 budget took the opportunity to raid the residential buy-to-let market on the back of several years of boom in this sector. The changes will prove to be damaging for a large number of owners.

Restriction of tax relief on interest

At present, full tax relief is available for interest on a loan used in a property business. The funds may have been used to purchase the let property, to make major repairs, or just to fund the working capital of the property business. From April 2017, tax relief on interest in property businesses (including single buy to lets) will be restricted so that by 2020, interest will not be an allowable expense in computing the profits of the business, but will attract tax relief at 20%.

A letting activity that has a low level of interest in relation to the borrowings will not be too badly affected, although those who have borrowed significant amounts to fund their buy-to-lets and larger property businesses using debt to expand the portfolio will find that their business model has been severely undermined.

How will it affect me?

Tony is a plumber with profits which use up his personal tax allowance and basic rate tax band, making him a 40% tax payer. He has a buy-to-let property with an affordable level of borrowing which is currently covered by the current level of rental income.  The effects of the budget change will be:

	2016-17	2020-21
Gross rents	12,000	12,000
Repairs and other tax deductible costs	1,500	1,500
Interest on mortgage	4,800	–
Net rental profit	5,700	10,500
Tax at 40%	£2,280	£4,200
Less interest relief at 20% on £4,800	0	960
Net tax liability on rental income	£2,280	£3,240
Tax Increase		£960
Effective rate of tax on rental	40%	56.8%

It is quite easy to see that if Tony was just managing to make his mortgage repayments of capital and interest prior to the increase in tax of £960 a year, he may now need to introduce additional funds and have a negative yield on the property.

For a larger portfolio the situation is compounded.  Using the example above, with Tony having other income which absorbs his personal allowance and basic rate band.  He has built up a substantial property business in his own name, not through a limited company. Rental profits after allowable costs are £40,000 a year he pays interest of £30,000.

With the current rules, Tony will have rental profits of £10,000 on which he pays tax of £4,000 at 40%.   Under the new rules his Income Tax bill will increase to £10,000 a year, a tax rate of 100% on rental profits!

Indeed, we have prepared the calculations for clients with substantial portfolios and large amounts of mortgage interest and in one case the tax bill changed from £5,600 a year at a 20% tax rate to £77,800 a year paying tax at the higher 45% rate. This equates to an effective tax rate of 144.4% on rental profits.

What can be done?

There are a number of options, unfortunately none is ideal.

• Repay the mortgage, either by selling assets or, if possible, by re-financing other assets.
• Sell the property. If you then wish to continue to invest in property, consider:
  • Investing via a company, where the rules do not so far apply;
  • Invest jointly with others in debt free residential property;
  • Invest in commercial property, where again the new rules do not apply;
  • Invest in a managed residential property fund.
• Do nothing, accept the larger tax bills and rely on capital growth for your profit.
• Sell all or part of your portfolio to your own property company. The company will need to take on the whole of the debt and you will need your mortgage lender’s agreement.

Each of these options has significant tax consequences to consider, including Capital Gains Tax now and in the future, Stamp Duty, Dividend Tax and Inheritance Tax.  Every case will be slightly different for tax and of course there will be commercial issues.   The changes start to apply from April 2017 which is not long when dealing with property. If you own buy to let property with a mortgage, then please contact a member of the property team at your local Wright Vigar office, or call our head office on 0845 880 5678 or email action@wrightvigar.co.uk – we would be delighted to assist you.