Stamp duty rise for buy to let properties and second homes and tax changes for landlords
Information is relevant on the moment of publication (April 2016)
Over the past few years the popularity of buy-to-let properties has remained high. Rising property prices, coupled with the increasing demand for rented properties, and low interest rates have all contributed to the popularity of the scheme, thereby allowing more landlords to receive profit from their buy-to-let portfolios.
However, upcoming changes might significantly alter this situation. To increase profit, and avoid potential losses, landlords will now have to plan their future buy-to-let purchases in greater detail.
Stamp Duty Changes
Recently announced changes will see an additional 3 per cent stamp duty on purchases of second homes and buy-to-let properties above £40,000. The additional 3 percent stamp duty will be added to every Stamp Duty Land Tax (“SDLT “) band, including the previously tax-free element. These changes will take effect from 1st April 2016.
This means that the tax bill on a buy-to-let property costing £450,000 will jump from £12,500 to £26,000. Further examples of how the SDLT changes will affect buy to let properties and second homes are shown in the table below.
Many landlords are already concerned about their diminishing returns on buy to let properties. For some landlords, this might be the “last straw”.
The SDLT change above is the second significant problem that buy-to-let investors have had to face in 2015.
Tax Changes – Mortgage Interest Relief
Earlier in the year, in the Chancellor’s Summer Statement 2015 it was announced that landlords will face greater tax on the profits from their properties from April 2017 with minimum tax relief dropping from 45 or 40 percent to just 20 percent. This means that landlords will no longer be able to deduct the cost of the interest on their mortgage from their rental income. This change will be implemented gradually from 2017 to 2020. It is expected that it will significantly decrease the profitability of some buy-to-let investments, and will result in losses for some buy-to-let landlords.
For example, under the current rules, if you earn a rental income of £20,000 per year from your property and the interest on the mortgage is £13,000 per year, you will only pay tax on the £7,000 profit.
That is a tax bill of £1,400 for basic-rate payers (20%), £2,800 for higher-rate taxpayers (40%), and £3,150 if you are an additional rate taxpayer (45%).
With the implementation of the new mortgage interest tax relief changes from April 2017, landlords will no longer be able to deduct their mortgage interest before calculating their tax bill. Instead they will get a tax credit equivalent to 20% basic-rate tax on the interest element of their mortgage.
Therefore going back to the example above, under the new rules as a landlord, you will now owe tax on your entire £20,000 rental income. However, you will get a 20 per cent tax credit for the £13,000 interest element, giving you back £2,600.
So, a basic-rate taxpayer will still have to pay the same amount of £ 1,400 (£20,000 * 20% - £2,600). But if you are a higher rate taxpayer, you will eventually have to give the taxman £5,400. Additional rate taxpayers would hand over £6,400.
It seems clear that interest rates would not have to rise that much higher before higher rate tax payers and additional rate taxpayers are left with no profits or losses after tax.
At first sight, basic-rate taxpayers appear unaffected. However, in reality, some basic-rate taxpayers will also pay more tax – because the change will push them into the higher-rate bracket, automatically increasing the amount of tax from the same level of income as they had before.
Intentions of the Government
The stamp duty and mortgage interest tax relief changes will affect the real estate market, as it would lead potential investors to re-evaluate the attractiveness of residential property investments.
On the other hand, in the short-term period prior to April 2016, the changes may cause a brief price increase in investment properties, as some investors will rush to buy before the new tax changes take effect in April 2016.
The changes are designed to adjust the unequal competition between investors and first-time buyers.
When delivering his Autumn Statement 2015, the Chancellor George Osborne said: “Frankly, people buying a home to let should not be squeezing out families who can't afford a home to buy. So I am introducing new rates of stamp duty that will be three per cent higher on the purchase of additional properties like buy-to-lets and second homes.” He continued “more and more homes are being bought as buy-to-lets or second homes” and “many of them are cash purchases that aren’t affected by the restrictions I introduced in the Budget on mortgage interest relief; and many of them are bought by people who aren’t resident in this country”.
This situation resulted in fierce rivalry between professional investors benefiting from buy-to-let properties, and buyers trying to get on the property ladder and purchase their first (owner-occupied) home. It has also triggered a sharp increase in the number of people renting properties in the private sector over the past years.
The Government wants to reduce the attractiveness of buy to let properties to investors, in the hope that this will make it easier for first time buyers and owner-occupiers to get on the property ladder.
The Government also hopes that the funds raised by the increase in the property tax will fund increased house building thereby boosting the supply of housing and making it affordable to buy.
The plan is to build 400,000 affordable new homes by the end of the decade, which would not just be affordable to rent, but affordable to buy. Half of the properties will be starter homes sold at a 20% discount to market value to young first-time buyers, and 135,000 will be Help to Buy shared ownership properties.
What to expect
The Stamp Duty increase has been harshly criticized by many industry professionals and landlords, with some calling the SDLT change “catastrophic news for the private rental sector”. The critics say (quite justly) that to keep buy-to let investments profitable landlords will have to pass the burden of the additional tax on their tenants, and that this will drive up rents and decrease the standards of the rental properties. The rents will also go up when mortgage interest rates rise as landlords will increase rents in a bid to maintain profitability of their investments.
It will also become more difficult for new landlords to enter the buy-to-let market, and this will widen the already existing gap between supply of properties and ever increasing demand. Therefore, rental values may increase as a result of further shortage of properties available to rent.
However, on the bright side, it should become easier for many first time buyers to finally get their own place.
Things to consider further
Buy-to-let landlords and owners of the second homes will need to watch out for further clarification of the changes, as it is yet not 100% clear how the announced SDLT changes will be implemented and monitored. The definition of a “second home” for SDLT payment purposes will need to be established in clear terms, as well as what to do in the situation when the buyer has not yet decided how to use the property at the time of purchase. We are also still to see how the definition of the second home will be applied to overseas buyers, who have their main property abroad.
Those who have already invested in buy-to-let or second homes in the UK, or who are planning to do so by taking out mortgages, will need to carefully recalculate their future returns in light of the recent changes in tax, specifically those announced in the Summer Statement, as the changes might result in a significant fall of rental income in subsequent years. However, those who were planning a buy-to-let purchase and who are able to finance the transaction in cash, should probably stop procrastinating and buy immediately, as from April 2016, buying the same property will involve additional Stamp Duty expenses.
Effective solutions from Law Firm Limited
The tax situation has been rapidly changing in the UK and it is crucial to carefully consider tax implications prior to making any buy-to-let or even first-home buying decision.
The recent SDLT changes for buy-to-let properties and second homes and the mortgage interest tax relief changes have altered the market of residential property investment. As a result of dynamically evolving rules and legislation, previously effective tax solutions may no longer be applicable or appropriate.
Our specialists will be glad to help you find new solutions in changing circumstances by developing fresh options, and minimising the negative effects of any recent legislative or regulatory changes on your investments.
We will be glad to advise you on matters of property purchase and investment, provide you with tax planning solutions, and develop individual solutions which will work for you.
Every case of property purchase, including buy-to-let, is different. Our specialists will evaluate each case individually for the prospects of future profitability with long term financial planning and professional tax advice.
We will provide you with a bespoke solution- specially tailored for you and your particular circumstances.
We have taken great care to ensure the accuracy of this article. However, the article is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from being taken based on this article