A good investment or a ticking time bomb! (What you need to know)
Are Buy to Let Properties still a good investment option?
In 2015 the Government, George Osborne then Chancellor, introduced a staged change that increased the income tax liability for some investors who bought as individuals. This has caused several investors to reconsider what they buy and how they purchase it.
So firstly, a reminder of what those tax changes were and their impact?
Higher rate Income Taxpayers and Buy to Let!
Mortgage / loan interest
It’s never been possible to claim the capital repayment element of your mortgage payments but, before 6 April 2017, you could claim all interest payments as a business expense when calculating your taxable profit. Since then there are restrictions on how you can claim the interest on any loans, with the changes being in brought in gradually and being fully implemented from April 2020.
Now your rental income gets added to any other income you earn from your employment or business. Your rental income is taxed at 20%, 40% or 45% depending on which tax band your income falls into. Important to note is that the rental income could tip you into a higher tax band resulting in an increased tax bill!
Unfortunately, there will no longer be additional relief for higher rate taxpayers, the deduction is limited to a maximum of 20% of finance costs.
Examples* based upon tax band:
The examples below are all based on the scenario that there is an investment property with a rental income of £750/month (£9,000/annum) with a £145,000 mortgage paying mortgage interest payments of £265/month (£3,060/annum). At this stage we have not included any property maintenance costs.
It is only when you pay tax at the basic rate of 20% that there is no impact on profitability due to the changes introduced.
In real terms, this means:
- Your taxable profits will be higher so you may pay more tax reducing your investment return.
- You must ensure all other tax-deductible expenses are claimed reducing your tax liability.
- You should review your BTL properties in the light of this increased taxation and the effect on your cash flow.
- If you are buying in joint names and are in different tax bands, it would be prudent to take tax advice. If the property is owned 50:50 rental income is allocated equally. Properties can be owned in different proportions; your legal adviser can help with this aspect.
- Some people would say this difference is not enough to make a difference to purchase or not – so where is the sting in the tail?
The “Sting in the Tail”
Two points cash-flow and interest rates!
There is an old expression that has stood the test of time: “Cash is King!” – it is the cashflow that impacts you well before profitability. So, when we look at what happens if, or when, interest rates increase you may have to pay tax even though you have no net cash after paying out loan interest and repayments!
The first profitability and tax examples above were using an interest rate of 2.19%. The 2.19% is not meant to indicate a good rate or a bad rate but a rate that is realistic in today’s market, investors may well have something similar in their portfolio. The Bank of England base rate is currently 0.75%. However, in the last 30 years it has averaged 4.44% based upon end of year comparisons.
Since we have had low rates for the last ten years some people argue it’s not a concern and some may never have experienced anything other than low rates and take it as the norm. However, lenders do stress test new mortgage application at higher interest rate to confirm the rental income is enough should interest rates rise.
So, using the same example, what happens when the interest rates rise?
With the changes in tax and a higher interest rate we now see that the profitability for the higher rate taxpayer is destroyed. This does not take into account any rental voids or property refurbishment / maintenance. Even the investor in the 20% tax band is impacted.
The “Big Hitter” would be if the rental income elevates you up a tax band, probably the most likely would be a 20% taxpayer increasing into a 40% tax band. This would reduce profit after tax from £4,656 profit to £3,456 or £576, subject to interest rates, a potential reduction of £4,080!
It is critical to note two points: The change in how you declare your income in your tax returns could now move you from a 20% taxpayer to a 40% taxpayer, see table above. Secondly, tax is not paid in the same fiscal period as the rent and profit generated which may cause a major cash-flow void!
What can we do about this?
Protect your cash-flow by reviewing your mortgage arrangements, if you plan on keeping the property, a longer-term fixed rate may well be more suitable than a short term 2-year fixed rate borrowing period. The market is competitive now, so it is a good time to take advantage of rates available.
Lenders will lend more to those fixing their borrowing costs for 5 years, calculations do vary, so it is worth using a mortgage adviser to establish the best option.
Limited company Buy to Let!
There are now a growing number of lenders who will fund a Limited Company Buy to Let. If you decide to use a limited company to hold your property portfolio, you will pay tax on profits as corporation tax. This rate is currently 19% on all profits.
You will potentially have to pay further tax when you want to take the profits out of the company as salary (PAYE/National Insurance) or dividends (dividend tax).
There is no annual allowance for a company’s capital gains on sale.
However, using a limited company may give you opportunities for a wider choice of tax planning, independent tax advice should always be taken, and there will also be higher admin and accountancy costs. Different inheritance tax rules apply, when transferring shares in a property company rather than transferring the properties themselves.
Lenders have specific guidelines around the acceptability of a limited company, for example it usually needs to be a SPV (Special Purpose Vehicle) with the correct SIC Code, rather than a trading company. I would therefore be prudent to discuss with us your proposal prior to setting up your limited company.
A Holiday Let mortgage is specifically for individuals or companies to borrow money to buy a property that will be let out furnished on a short-term basis to tourists. For a property to count as a holiday let, rather than a buy-to-let, it must be available for letting as furnished holiday accommodation for at least 210 days per year. This differs to a second home or holiday where the owner is the only user of the property.
A Holiday Let is still classed as a business therefore you can deduct all your expenses from your rental income before you are assessed for tax. This includes 100% of the interest you are paying on your mortgage. Finance costs includes mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans.
Contact us to see how we can help you secure the right mortgage to help protect your investment income.
NOTE: We recommend landlords consult an accountant about their personal situation. We can help with local contacts if required.
Tax information is based on our understanding of the changes to tax legislation introduced in 2017 and may be subject to further change. No information on this site should be taken as tax advice. For advice you should consult with an independent tax adviser. Be aware that according to your situation, other taxes may apply and there are special rules for non-UK residents.
Your property may be repossessed if you do not keep up repayments on your mortgage.
* Examples provided by using The Mortgages Works BTL tax calculator – General assumptions: You have no other sources of income – The above examples are indicative and don’t cover all scenarios. Your circumstances will determine your total tax liability – Rental income and mortgage costs remain the same over time. Mortgage repayments are calculated on interest only basis – In some circumstances, losses may be carried over to subsequent tax years, these examples do not take into account any losses – As tax is paid in arrears, these examples are not representative of cash flow