If you’re new to buy to let, you might not appreciate the full implications. Up until now, people buying property to let have been able to claim tax relief on their mortgage interest payments at their marginal rate of tax. This means that a basic rate taxpayer would get 20% tax relief, but those at a higher rate would receive 40% relief, while top-rate taxpayers could claim 45%. This will change completely by 2020 when all tax relief will be set at the lower rate of 20%, the change will be gradual and will be implemented over a 3 year period starting back in 2017.
The impact of this on your basic rate taxpayer is zero, but on a higher rate taxpayer the changes are significant and will lead to a large increase in costs that in a lot of cases, may lead to the properties concerned becoming no longer viable. This, although sounding harsh, was the intention of the government, who in turn hope that with a drop in demand from investors, prices will drift and allow first time buyers to enter the market. This is in addition to SDLT changes, where a second home now attracts a 3% surcharge on top of existing Stamp duty rates, plus a raft of other changes that have put the buy to let market on the back foot.
So, what can you do as an investor to mitigate these changes? One of the largest impacts has been felt by the 3% surcharge on stamp duty for a second home, and one way that has been highlighted lately of avoiding this involves altering the ownership of the main home that allows you to technically avoid the extra charge when one of you goes to buy a second property. How does this work? Well, the unintentional loophole has occurred due to the difference between property law and the HMRC ruling. The contentions point is the phrase, ‘major interest’. HMRC rules state that any stake in a property is a major interest, property law on the other hand states that an undivided share, when ownership is split between 2 people, does not satisfy this requirement, and therefore the charge does not apply. This is a technicality, and although is correct in the letter of the law, it is not what the HMRC intended so could be questioned. Advice on this needs to be obtained from a qualified person, notably an accountant, and should not be acted upon without prior consultation.
Another way to avoid the dreaded stamp duty surcharge, and in fact the stamp duty altogether is to purchase a PBSA. Student property I hear you cry! Well, student property is fast becoming a viable alternative to the residential buy to let market where these problems have begun to bite. Student property has moved on a pace and these purpose-built studios, with all the latest facilities, are fast becoming the required standard, especially for universities that attract a large foreign student population who are prepared to pay higher rental rates to house their children.
Now let’s look at the loss of tax relief at the higher level, and what impact that has had and how to mitigate its effects. One solution, of course, may be to increase rents so that the extra cost is passed on to tenants – but this solution is far from ideal. Most tenants are already paying as much as they can afford, and you risk pricing yourself out of the market. However, if you think you will be affected, there are a few other things you can try:
1. You could switch to shorter-term fixed-rate deals to get lower rates of interest, although these mortgages carry more risk.
2. You could place your property portfolio in a limited company structure. You would then pay corporation tax (which is lower) rather than income tax on your profits. A drawback is that your mortgage options will narrow, as fewer providers will lend to a company.
3. If your spouse pays a lower rate of tax, you could transfer ownership of one or more properties to them (taking care this does not lift them into a higher tax band).
As with most clouds, there is a silver lining. If you’re a landlord with a lower income, you’re no longer at such a disadvantage to those in the big league. This level playing field may in fact help the new wave of ‘silver landlords’ hoping to use their pension pots to buy rental property. Also, if you’re a homebuyer, you may find prices becoming more affordable as the competition from buy-to-let decreases.
Where Does this Leave Buy to Let?
In general, the market in buy to let remains a strong proposition, but you have to assess the affordability and viability of it as a business, this means the property market becomes a more efficient and easier market to enter as a large number of people who should not be entering the property market are forced to drop out, leaving serious investors who spend time and effort planning and structuring a solid business model to flourish.