George Osborne’s July Budget, delivered in the wake of the general election and aimed at building a broad consensus on the centre ground of British politics, contained several measures aimed at addressing a perceived imbalance in the housing market between property investors and owner-occupiers.
The chancellor stated he wanted to limit the tax relief available to buy-to-let landlords, something he said gives landlords a “huge advantage” in the market and which, in the chancellor’s words, “has contributed to the rapid growth in buy-to-let properties, which now account for more than 15 per cent of new mortgages, something the Bank of England warned could pose a risk to our financial stability”.
To achieve this, the chancellor announced that mortgage interest relief on residential property will be restricted to the basic rate of income tax with higher rate reliefs phased out over a four-year period, beginning April 2017.
While the chancellor’s stated aim of “levelling the playing field” between property investors and owner-occupiers sounds fine in principle, the devil is, as always, in the detail. Growth in the BTL sector also needs to be put into context. While it is true that the sector has seen growth in recent years, levels of BTL lending in 2014 were at the same as they were in 2004. Furthermore, the scale of BTL lending in comparison to the owner-occupied market is frequently exaggerated by the level of remortgaging, which exceeds 50 per cent of all gross lending.
The changes announced by the chancellor are complex and will apply to each landlord individually in different ways. While these changes will be phased in over a four-year period starting in April 2017, it is vital that brokers start talking to their landlord clients now and making sure they are aware of how these changes will impact them, giving them adequate time to plan appropriately.
Only time will tell exactly how many, and to what level, landlords will be impacted by these changes, but it is worth noting here that currently, the private rented sector is the UK’s second largest housing tenure, serving 4.9m households. So the impact of these reforms needs to be considered carefully.
So, what do the changes mean for landlords, and what do they mean for financial advisers?
Landlords are financially savvy and data shows that most of them invest in the private rental sector over the long term.Indeed, data from the Association of Residential Letting Agents (Q4 2014) shows that on average landlords expect to retain their investment for 20 years. However, guidance will still be needed in order to plan for the new tax regime and ensure they are prepared. For landlords paying a basic rate of tax, while they need to be aware of the coming changes to tax relief, the potential impact on their tax bill is limited.
Consider for example Chris, from our graphic examples. After interest repayments on his property finance, he generates an income of £6,000 from his rental properties, which, combined with income from other sources, brings his total STI to £21,000. He remains in the lower tax band and his tax does not change.
Other basic rate taxpayers, however, may find themselves shifted into a higher tax band. Consider our other example, Joshua. He also generates £6,000 (after financing costs) from his rental properties but, combined with his other earnings of £35,000, Joshua’s STI is now at £41,000. As such he is pushed into a higher rate tax band and his tax bill is increased from £1,200 to £2,723. However, while this landlord’s after-tax property income will fall, he will still benefit from the capital appreciation of his properties over time.
Looking at the large-scale landlord end of the market, these landlords, who may hold significant portfolios in their own names, may be affected to a greater extent, but may consider incorporation to mitigate the cost – more on this later.
Regardless of these changes, BTL will remain an attractive option for investors. The UK’s PRS is home to millions of people, an increasing proportion of whom are actively choosing to live in the sector because of the choice and flexibility it affords them. It is a sector expected to continue growing. Research undertaken by PricewaterhouseCoopers predicts that, by 2025, just under 25 per cent of housing will be in the PRS. So, with this rising demand from tenants for good quality rental homes, landlords are likely to see ongoing opportunities for investment in the sector.
In order to provide the best possible advice to property investors, it will be essential for financial advisers to fully familiarise themselves with the new rules and the impact they will have on returns throughout the transitional period and once the rules are fully in place. New customers will need to fully understand the changes also and financial advisers might consider sign-posting them towards tax specialists who will be able to look at their long-term tax planning. Advice and information are also available from trade bodies such as the National Landlords Association.
There are further solutions financial advisers might want to consider, on a case-by-case basis.
For example, could incorporation be an option? Limited company profits, including rental income, below £300,000 are currently taxed at 20 per cent. This would free up money for reinvestment in new properties and the upgrading of existing properties. And in the same Budget as a reduction in tax relief for landlords was announced, the chancellor also stated that the government would be reducing corporation tax to 18 per cent by 2020. So there are several potential benefits to holding buy-to-let properties in a corporate structure.
Ultimately, however, what is clear is that there is no one-size-fits-all approach to how landlords will deal with these changes. Only as landlords, and lenders, continue to gather evidence and watch the trends among customers and potential customers, will the full implications of the summer Budget become clear. In the meantime, it is crucial that investors and advisers ask the right questions to ensure their business remains sustainable when the phase-out of the current system begins in 2017.
John Heron is director of mortgages at Paragon
Key points
In the summer Budget, the chancellor stated he wanted to limit the tax relief available to buy-to-let landlords.
Data shows that most landlords invest in the private rental sector over the long term.
It will be essential for financial advisers to fully familiarise themselves with the new rules.
