How will the new buy to let tax work?

buy to letThe new tax year saw the introduction of major changes to the taxation of buy-to-let (BTL) investments. What will these changes mean to you, and what can you do to avoid giving more of your rental income straight to the taxman?

What exactly is buy-to-let?

Buy-to-let has become a major factor in the property market. Buying a home to let out is no longer the preserve of professional landlords. Low returns from savings and annuities have seen many people turning to buy-to-let as a more remunerative alternative.

It offers the prospect of a steady income and capital growth, and buy-to-let mortgages put a property portfolio in reach of a large proportion of homeowners.

But although BTL can provide attractive returns, it may be making it harder for first time buyers to get on the housing ladder.  All the suitable properties are being snapped up by investors.

Increased taxation of buy-to-let investments may have less to do with a need to fill HMRC’s coffers, and more to address the effect of a BTL boom on the housing market.

What are the changes?

Income from rent is taxable. Certain expenses can be deducted.

  • Property repairs and maintenance
  • Interest on buy-to-let mortgages
  • Legal, management and other professional fees such as letting agency

The rest is charged according the landlord’s tax band. Landlords paying higher (40%) or additional (45%) rate tax could claim tax relief at their highest rate. From the beginning of this tax year, this has changed. Tax relief will only be reclaimed at the basic rate (20%).

The reduction is being phased in between now and 2020. Landlords can now offset only 75% of their mortgage interest against their profits. This falls to 50% next year, and 25% in 2019. In 2020 it will fall to zero, and be replaced by a 20% tax credit.

If you’re a landlord who only pays basic rate tax, this change won’t affect you, but if you pay at higher (40%) or top rate (45%), you’ll be paying more. Some basic rate taxpayers will find themselves in the higher rate bracket when their rental income is taken into account.

The net effect is that if you have BTL property, you will have more tax to pay, whether or not you are making any profits.

The changes apply only to private individual landlords and not to those who own property through companies.

Another change is the removal of the “wear and tear” allowance. Previously, you could claim 10% of your rent as tax relief for wear and tear. Now the allowance is being replaced by a system that only allows tax relief when you replace or refurbish.

What can you do about the increase?

Some BTL landlords will find that their investments are no longer bringing in the returns they want, and may consider selling them. This could mean very large capital gains tax bills.

Others, who may have smaller mortgages, and face a less frightening tax hike may be able to improve their position. This may be by reducing the mortgage amount still further, by getting a lower mortgage rate. One way of doing this is by remortgaging a main residence to pay off mortgages on buy-to-let properties. Home owners typically get lower rates on residential mortgages than buy-to-let mortgages.

A third solution may be to increase rents, to gain additional income to cover the tax increases. This could lead to the loss of good tenants and costly voids.

Those with larger portfolios might also have the option of moving properties inside a company. This may avoid the tax hikes on individuals, although it would mean additional costs and administrative complications.

What should you do now?

The government has made an important concession in phasing in the tax hike, but the changing tax position will affect BTL investment. Understanding exactly what your position is, and finding the best way for you to deal with the growing extra tax burden is essential.

Talking to our experts at Continuum may be the best way to start preparing for these changes.

Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change.

The Financial Conduct Authority does not regulate most buy to let mortgages

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