The Landlord and the Taxman

The Buy to Let Market is going through a period of significant change. Over the last couple of years, the Government has taken an active interest in this sector and made a number of announcements that are likely to affect the Buy to Let landscape.

Firstly, let’s recap on the changes that have already been implemented. The biggest so far, made in April 2016, was the increase in Stamp Duty Land Tax (or Land and Buildings Transaction Tax for properties in Scotland) when all rates were increased by broadly 3% for additional residential purchases. This had a direct impact on purchasing property for letting by increasing the cost of buying.

Announced alongside these were changes to income tax in relation to the wear and tear allowance. A tax deductible expense will now only be allowed for actual costs incurred, for example when replacing furnishings, rather than as a flat allowance on furnished properties. There’s also been a speeding up of the payment of any Capital Gains Tax liability where applicable, and payment is now due within 30 days of disposal of the property.

Perhaps the biggest changes are still to come and these are the changes to tax relief on mortgage interest. At present, landlords can deduct mortgage interest and other allowable costs from their rental income before calculating their tax liability.

New rules being phased in from April 2017 will mean that by 6 April 2020, tax relief for finance costs will be restricted to the basic rate of income tax, currently 20%. Relief will be given as a reduction in tax liability instead of a reduction to taxable rental income. For a higher rate taxpayer, this means that their rate of tax relief will gradually reduce over the four years as the table below shows.


Tax relief on finance cost
2016/17
2017/18
2018/19
2019/20
2020/21
Existing system
100%
75%
50%
25%
-
New system
-
25%
50%
75%
100%

The impact of these changes are many and varied. Landlords with unencumbered properties won’t be impacted, while others who are basic rate taxpayers may be affected if the change in tax calculation liability pushes them into a higher rate tax bracket.

For higher rate taxpayers there’s also a potential impact on the profitability of their rental property or portfolio as their income may be reduced. For those who are highly geared or on expensive interest rates this may move them into loss making territory. Across the board, landlords may want to consider their investment strategy and seek professional tax advice. You can see how different scenarios could affect landlords by taking a look at TMW’s website.

In the meantime, in light of the market, tax and regulatory changes, lenders are reviewing their criteria to ensure that their own attitude to risk now reflects these considerable changes. To this end most have increased their Interest Cover Ratio (ICR) and they’ve also had to increase their stress test rates to a minimum of 5.5% for certain products. These measures are likely to have an impact on loan size and the amount that can be borrowed in terms of Loan-to-Value.

And there are still more changes to come. Lenders will need to consider reviewing the way they underwrite cases from landlords with a portfolio of more than four properties from autumn 2017. In addition, the Government has launched an enquiry into charges and fees made by letting agencies to prospective tenants. This seems aimed at unreasonable charges but is also likely to have an impact on the landlord.

After 20 years of growth the private rental sector is now a vital part of the housing market with almost 1 in 5* households living in rented properties. It’s clear that all these changes are going to have an impact on lenders, landlords and tenants over the coming years and 2017 promises to be a memorable one as the market adjusts to the new regime.

Lenders and landlords are going to have to rise to the challenge of maintaining this vital part of the housing market.

For more information about tax relief changes for landlords, visit themortgageworks.co.uk/TaxChanges

* Source: Department for Communities and Local Government