It’s been almost a year since the government announced the changes to tax relief on buy-to-let properties – news that made all landlords wince. Having enjoyed 100 per cent tax relief on mortgage interest payments up until that point, landlords are now faced with hikes that will require some consideration if they are to minimise impact on income.
For those who might have been burying their heads in the sand over the impact of these changes, it’s time to wake up and start planning. While the changes are being phased in gradually to avoid sudden increases in income tax, they have already started to hit. This financial year (2017/2018) saw the interest rate tax relief drop to 80 per cent, 2018/2019 will see a further drop to 60 per cent, and over the next two years it will be down to just 20 per cent. This isn’t music to the ears of anyone who owns a buy-to-let property and requires careful thought for those who might have been considering this as a viable investment.
What will the impact be?
For those with a small portfolio and perhaps earning a salary falling in the basic rate tax band, income generated through profit on rental properties could now push them into a higher rate tax bracket, as the tax relief is lower. Even those who think they are currently safe and that their rental profit won’t yet push them into a higher rate tax, may not be once the relief percentage falls dramatically over the next few years. It’s worth thinking now about a plan of action. For those on a fixed-term high interest rate, this erodes profits further.
For landlords with larger portfolios, of course, the impact will be much higher as it will be multiplied across many properties. There are some great example case studies available on the HMRC website.
Potential solutions to help cover losses
Many landlords will be going down the route of rent increases to help cover the additional costs associated with the tax relief cuts, according to the Residential Landlord’s Association (RLA). This is a viable solution but there will be a balancing act to keep rents reasonable and affordable, so as not to be priced out of the market – impacting profits further.
Switching mortgages to get a better interest rate is another solution, but many of the better deals come with short-term fixes, and with interest rates set to go only one way, it can be a risky strategy. Putting your property or properties into a limited company, so tax will be paid at corporate tax rate rather than income tax rate, is also an option.
Considerations for would-be landlords
The above changes on tax relief on properties, and the fixed three per cent stamp duty on buy-to-let properties, might make the buy-to-let market a less attractive investment option than would previously have been the case. However, many might still be interested in exploring the option, with interest rates on savings still low.
But being a landlord isn’t a walk in the park. Provisions must be made and contingency built in for the realities of renting out property.
Funds to cover periods where your property isn’t rented out, either because of necessary repairs or a gap between tenants, will need to be built in. Additionally, if you have to have tenants removed, this can be a lengthy and expensive process and usually results in a period of non-payment during that eviction process. While it is possible to gain a decent deposit up-front to cover such an eventuality, the possibility of the introduction of a new cap on deposits could remove that security. The government’s Draft Tenant Fees Bill is proposing the cap, which according to the RLA, will not be sufficient to cover a potential eight-week period of non-payment, let alone address any damages that a tenant may leave behind. The RLA warns this bill could become a ‘charter for rent cheats’.
Lending is also becoming more difficult and proof that the mortgage could be covered from normal income in the event of the property not being let is often required.
Add agents’ fees, property maintenance and meeting obligations such as Gas Safety Certificates and fitting and testing of smoke alarms, among others, and the costs can soon rack up.
Whether you are already a landlord and need to think about your options in the wake of the tax relief cuts, or are considering buy-to-let property as an investment, it is wise to see a tax adviser to ensure there are no nasty surprises to catch you out further down the line, and provisions are made for the increasing cuts on relief.
Neil Lancaster is partner at Tamworth accountancy and business adviser firm