How to navigate buy-to-let changes

The first thing Mr Osborne did was to make a change to the way in which landlords can claim ‘wear and tear’, by replacing the allowance with a charge on a cost-incurred basis.

Until 6 April 2016, landlords were able to claim 10 per cent of the net rent as ‘wear and tear’ allowance for furniture and equipment provided with a furnished residential letting.

Net rent, according to the government website, is “the rent received, less any costs you pay that a tenant would usually pay, such as council tax”.

But this allowance was being replaced with a relief that will mean landlords of residential dwelling houses can now only deduct the costs they incur on replacing furnishings in the property.

The changes are far-reaching and punitive. They have created a new type of market. Martin Reynolds

Also in the Summer 2015 Budget, the chancellor announced buy-to-let landlords will receive a lower rate of tax relief on mortgage payments.

Before April 2017, landlords could take advantage of loan interest relief up to 45 per cent. Now, it will be reduced to a flat rate of 20 per cent tax credit - under changes to the taxation of mortgage interest. These changes will be phased in gradually until 2020.

This means landlords can no longer deduct the cost of their mortgage interest from their rental income, so tax will be applied to the rent received, rather than net rent - that which is left of the rent after the mortgage interest has been paid. 

This could transform properties that currently generate positive cash flow into a loss-making investment (on an income basis) because of the extra tax, and could mean some landlords receive no profit at all, as it will be eroded by the tax payments and mortgage interest.

Jeremy Duncombe, director for the Legal & General Mortgage Club, comments: “Higher-geared portfolios will suffer more from these tax changes, so landlords in this situation should contact a broker to consider remortgaging.”

Thinking ahead

A lot of professionals at the time considered bringing forward any property purchases ahead of the 2016 rate increase, which according to Louisa Sedgwick, director of sales, mortgages, for Vida Homeloans, gave a “false reading in the market”.

She explains: “The SDLT deadline gave a false reading in the market as buy-to-let property purchases were simply brought forward to avoid the additional duty”.

Many of these properties were put into special purpose vehicles – limited companies – as it was believed incorporation could protect landlords against the full impact of SDLT, adding an additional layer of complexity to buy-to-let investment.

“Many landlords were wondering whether incorporating will be a good idea in light of the higher tax bills heading their way”, says David Hollingworth, associate director of communications for London and Country Mortgages. 

“There are certainly some attractive headlines to this, not least the ability to set mortgage interest against income as an expense and the lower rates of tax paid on corporation tax”.

And Ms Sedgwick believes concerns over the SDLT hike have been overblown: “Landlords quickly realised that while SDLT is an unwelcome expense, capital growth could still ensure the overall investment return remains attractive.”

Harry Landy, managing director of Enterprise Finance, says SDLT did have an impact on the market, causing a rush to buy in March 2016, followed by a more subdued market for buy-to-let purchases. He also cites the rising use of SPVs as a means to mitigate the effect of the stamp duty surcharges.

However, Mr Landy believes there are bigger challenges when it comes to existing buy-to-let assets for landlords that are held in the individual’s name.

According to him, this presents two challenges:

Challenge one: "Mitigating those tax implications and ensuring the property is still economically viable is a significant challenge. How that will play out is not yet clear, though some smaller landlords will likely sell-up.

"For advisers, new developments may emerge to help clients manage transferring properties into limited companies, and there’s certainly much interest in 2013’s Ramsay vs HMRC ruling in this arena.

"However, that’s as much a tax consulting issue as a mortgage one, so advisers would do well to work with their client’s tax consultants."

Challenge two: Mr Landy says: "The second challenge is raising new capital on existing BTL assets. With new guidelines on higher rental income coverage of mortgage payments, the High Street is typically allowing existing borrowers to remortgage to better deals, but only on a £-for-£ basis of their existing capital.

"Should a borrower wish to release equity – for example, to expand their portfolio – they may be trapped, as they can only remortgage on the higher rental income test. Here, advisers could consider second charge buy-to-let mortgages, which specialist lenders can and will do."

Large or small?

Just as the market was starting to get accustomed to the various changes announced in 2015, the 2016 Budget had more tax changes in store for property investors. 

Mr Osborne made it clear that landlords with more than 15 properties will not be protected from the 3 per cent SDLT.

In his speech, Mr Osborne said: “There will be no exemption from the higher rates for significant investors, and the higher rates will apply equally to purchases by individuals and corporate investors.”

The chancellor made it clear these higher stamp duty rates would help to raise £60m towards the government’s investment in community-led housing developments (for first-time buyers) - especially in areas “where the impact of second homes is particularly acute”.

The SDLT also affected commercial rates. Previously SDLT for commercial property transactions was charged on the old-fashioned “slab” basis rather than the marginal basis brought in for residential property in December 2014.

However, the chancellor announced from 17 April 2016 commercial property would be brought into line with the SDLT and thresholds for non-residential rates, with various bands.

The 2015 stamp duty hike was aimed at higher-earning landlords, so those who pay 40 per cent or 45 per cent income tax were set to be greatly affected, and market commentators last year warned that a hike on SDLT could push more people into the higher-rate bracket.

As the Council of Mortgage Lenders pointed out in 2015, imposing an extra 3 per cent tax on purchases could make some properties at £125,000, which are currently exempt, subject to this tax for the first time. 

However, the current chancellor, Philip Hammond, has confirmed higher personal allowances, so this might go some way to mitigating the numbers of landlords who risk being pushed into the higher-rate bracket.

Basic tax payers on a standard tax code will see their personal allowance rise from £10,600 to £11,000 on 6 April 2016 and again to £11,500 on 6 April 2017.

The threshold at which higher rate tax becomes payable by individuals with standard tax codes will also rise, from its current level of £42,386 to £43,000 this April and £45,000 in April 2017. 

Capital gains tax

There was also another snub to landlords in the 2015 Autumn Statement, when Mr Osborne laid out changes to the manner and timing of capital gains tax (CGT) payments.

This meant any CGT payments must be made within 30 days of a sale of a buy-to-let property from 2019 onwards, whereas previously the payment could be deferred by up to 21 months.

Then, in 2016, Mr Osborne said CGT would fall from 28 per cent to 20 per cent for higher rate tax payers and then from 18 per cent to 10 per cent for basic rate tax payers.

While this was good news for investors in stocks and shares, these new, lower rates will not be applied to gains on residential property or carried interest, for UK residents or non-residents.

This could have a knock-on effect on those landlords seeking to use SPVs to mitigate the effects of SDLT. Mr Hollingworth explains: “Switching existing property into a company will result in stamp duty being payable and a potential CGT liability.”

Accidental landlords and other legislation

In November 2015, Mr Osborne said the increased stamp duty rate will apply where, at the end of the day on which a property is acquired, the individual concerned owns two or more residential properties and is not replacing his or her main residence, which has been sold within the last 18 months.

This would have seriously affected accidental landlords, who may have inherited a property from their parents or grandparents. 

Significant lobbying and discussions with the industry saw a slight concession. In 2016, Mr Osborne increased the 18-month period in which to replace the main residence to 36 months.

Add to this the changes being brought in by the Prudential Regulation Authority (PRA), and the situation has become even more difficult, according to Chris Ioannou, senior IFA for Prestige.

In 2016, the PRA expressed concern about the quality of buy-to-let investing, suggesting the growth of the market could be leading to potential problems with affordability and indebtedness down the line.

The changes in tax legislation are going to deter more amateur clients from becoming landlords, as they are likely to be heavily taxed on the increased income. Jamie Smith-Thompson

After a review, the PRA published its Underwriting Standards for Buy-to-Let Mortgage Contracts paper, which seeks impose macro-prudential regulation on the way in which lenders were providing and underwriting both complex and traditional buy-to-let products. 

In particular, it said: "there is a risk that firms relax underwriting standards, thus affecting their safety and soundness. The findings suggested a need for microprudential action".

The paper proposed that all firms use an affordability test when assessing buy-to-let mortgage contract in the form of either a mortgage interest coverage ratio (ICR) or an income affordability test, where firms take account of the borrower’s personal income to support the mortgage payment.

It also proposed that firms consider: 

• All costs associated with renting out the property where the landlord is responsible for payment.
• Any tax liability associated with the property.
• Where personal income is being used to support the rent, the borrower’s income tax, national insurance payments, credit commitments, committed expenditure, essential expenditure and living costs.

Mr Ioannou states: “These changes to lenders’ assessments and stress test rates may leave potential buy-to-let investors needing to put down far greater deposits to meet new lender criteria.”

Moreover, according to Legal & General Mortgage Club’s Mr Duncombe, this could lead to a contraction in the market, or at least a slowdown in new entrants.

He explains: “There is a consensus in the market that fewer landlords will enter the UK market, with existing landlords potentially increasing rents to offset their extra costs.

“Subsequently, many of our brokers think the buy-to-let market will shrink slightly over the next 12 months.”

New norm

All these changes have served to muddy the waters for buy-to-let landlords, especially when it comes to complex buy-to-let. 

Martin Reynolds, chief executive of SimplyBiz Mortgages, has strong opinions on this. “The changes are far-reaching and punitive. They have created a new type of market.”

He adds: “Rental calculations and affordability are already here, with new portfolio rules to come in October.

“If you add in the new tax rules being phased in, and the 3 per cent stamp duty, you have a rapidly changing market.

“Helping clients is all about educating them on what has changed, what will change and where they can get the best advice.”

Jamie Smith-Thompson, managing director of advice firm Portafina, comments: “The changes in tax legislation are going to deter more amateur clients from becoming landlords, as they are likely to be heavily taxed on the increased income.

“Putting additional structures in place to mitigate this adds unwanted complication and processes if you are doing it on a small scale”

Ms Sedgwick adds: “As these changes are being phased in over the next four years, the new ‘norm’ has not been established.

“Intermediaries must ensure before embarking on any buy-to-let mortgage applications, their landlord clients have taken professional, qualified tax advice – and they must, must, must make sure they document this fully.”

“IFAs are not primarily tax experts”, agrees Mr Smith-Thompson, adding: “This may call for partnering with an accountant to ensure the tax scenario is covered thoroughly.”

simoney.kyriakou@ft.com