The soaring price of property and the associated rise of Generation Rent have put buy-to-let in the spotlight. The introduction of an additional 3% stamp duty on second homes, announced in the Autumn Statement, follows significant changes to landlords’ tax relief.
Property to let is the only type of investment where it’s possible to borrow money to invest and then claim full tax relief on the interest payments. This is clearly a tax break that the Chancellor feels is ripe for reform and between 2017 and 2020 higher rate tax relief will effectively be withdrawn.
Basic rate taxpayers may also be affected as the new rules will mean that tax is due on income before the deduction of interest payments, rather than on net income as is currently the case, pushing many into the higher rate band. A 20% tax credit on mortgage interest will then be available.
The table below provides an example of how the rules will affect private landlords. Those with larger mortgages and lower yielding properties will suffer most; some may even start to make a loss.
Comparison of Buy to Let Income & Profit for a Higher Rate Taxpayer – 2015 vs. 2020
|Year||Income||Mortgage Interest||Taxable Income||Income Tax @ 40%||Tax Credit @ 20%||Tax Paid||Profit|
This approach to investment property taxation will not apply to furnished holiday accommodation – a relief to many in our locality – or to properties managed through a company.
As a result, many landlords are now considering the merits of managing their property through a company, however this isn’t without it’s issues either. There are two layers of capital gains tax: first in the company and then on the disposal of any shares. And as companies are immortal, the capital gains exemption on the death of an individual who owns an asset directly will not apply. Extracting any profits via dividends will also become more expensive after April 2016 when all taxpayers drawing more than £5,000 will be subject to an additional 7.5% tax.
The further attack on the buy-to-let market is the abolition of the wear and tear allowance. Landlords can currently deduct 10% of the net rent, whether or not they actually spend this money. The proposal is that only actual expenditure would be tax deductible.
And these changes follow fast on the heels of other recent Government interventions. Since April 2015 foreign investors will be required pay capital gains tax on any UK property, which, together with the new 12% (soon to be 15%) top rate of stamp duty may make some look elsewhere for their next investment.
‘I put my faith in property’ – Don’t be so Sure
So, property as an investment is certainly facing some considerable headwinds, but many people I meet still believe that a shortage of supply will continue to drive prices higher – ‘house prices will never fall’. This statement isn’t true of course; for example, between 1988 and 1993, London house prices fell by almost 30%. Over time prices recovered, but it took nearly a decade, and much longer in real terms.
Valuations again look stretched. This doesn’t necessarily mean that prices won’t rise even further, but the ratio of London house prices to average incomes is now the highest on record and we are close to that point in the South West too. Despite this, mortgage payments, expressed as a percentage of income, are only just above their long-term average, so affordability remains reasonable. That picture would change considerably if interest rates rose again to ‘normal’ levels.
Rising interest rates and taxes may therefore create a perfect storm for property investors in the coming years. The good news is that our children will be delighted.