Tax Digital

As most of us in the residential property investment sector are already aware last Thursday saw the introduction of the first phase of a new government tax move to penalise landlords.

Legislation cutting tax relief for higher earning landlords (those earning more than £40,000 per annum) will be phased out gradually over four years and replaced with a standard 20 per cent tax credit. Before April 6, higher earning landlords were able to deduct mortgage interest payments of up to 45 per cent from their tax bills.

Like the 3% Stamp Duty on BTL and second homes, the new legislation is intended to hurt landlords in the pocket. And certainly, for some landlords, they’ll be paying more in tax than they make in profit. That’s because they’ll be charged on their full rental income (rather than just profit).

Investor Steve Bolton, who led – and lost – a court challenge to get the government to overturn what he refers to as the ‘Tenants Tax,’ is angry that no other business is being taxed in the same way buy to let landlords are. And, he calculates that the tax changes affecting rental income will push a further 440,000 landlords into the higher tax bracket (which could then their affect other income streams such as Child Benefit payments).

How landlords will seek to recoup lost tax relief

The government believes that if landlords don’t buy up housing stock then it will ease the housing shortage by making more homes available and, at the same time, reducing the cost of these properties for buyers.

Well it’s true that the clampdown on landlord’s profits have seen some buy to let investors leave the property market altogether, but the majority will stay and look for other ways to recoup their lost tax relief costs. This could include increasing existing rents, getting rid of their estate agent and carrying out their own property servicing (saving up to 15 per cent) or even looking for less expensive tradesmen to carry out repairs.

For those with more than one property and a fair amount of mortgage interest, there’s also the option of moving to a limited company (provided it makes financial sense and they can leave the money in the bank for some time). That’s because, as a limited company a landlord would pay corporation tax (currently 20 per cent but falling to 17 per cent by 2020).

How landlords could benefit from the tax change

Some landlords may be better off with the introduction of the tax changes – because it may be the encouragement they need to remortgage. In doing so, they could very well find a pleasant surprise. That’s because interest rates on buy to let mortgages have fallen over the past few years while, at the same time, property prices have risen. As a result they could have a much better LTV rate and a wider range of mortgage providers to choose from in order to get the best deal possible.

Of course another way to cut costs is to pay off the mortgage altogether – but most landlords don’t find themselves in this enviable financial position. Instead, those for whom mortgage interest payments make up a large part of their rental income could re-assess their property portfolio and reduce it to cut back on tax payments.

Yet another idea could be to invest in off-plan property rather than a new-build or older property. That’s because off-plan tends to be less expensive, with many cash-only deals. The value of the property may also increase during construction.

Some landlords have quit the capital altogether and headed north to cities such as Leeds, Manchester and Glasgow where yields are higher. Others have considered swapping into the semi-commercial residential sector (ie a flat above a shop) since they’ll then still be entitled to claim full mortgage interest relief.

The residential buy to let sector is changing but not, we suspect, in the way the government intended it to.