Property: Three swipes of the ex-Chancellor’s pen have worsened investment properties’ tax efficiency. Danny Cox looks at the increasing pain for buy-to-let.
Private landlords investing in property were an unusual sight until the mid-1990s, when the first buy-to-let mortgages became available. This makes the BTL market as we know it just over 20 years old. Since then, it has grown to around 17 per cent of total of mortgage lending by number of households. It has been boosted in recent years by low interest rates as borrowing costs fell and savers and investors looked elsewhere for yield.
This growth has occurred despite investment property being one of the least tax-efficient ways to invest; subject to stamp duty, income tax, capital gains tax and inheritance tax with few reliefs to offset.
In recognition of the fact that the rise in the numbers of landlord investors appears to be pricing out first-time buyers, a series of tax changes are in train, aiming to dampen BTL demand. Investors now face higher taxes on entry, higher periodic taxes (lower reliefs from April 2017) and higher exit taxes than before, relative to other options.
Stamp duty
Stamp duty was initially reformed as of midnight on 3 December 2014, the day of that year’s Autumn Statement, when it moved from a slab to a tiered system. Then-chancellor George Osborne’s overhaul was designed to reduce the tax on purchase for lower-value properties and increase the take at the upper end, while making the system fairer and removing some of the pricing inequalities that had emerged.
A further move from 1 April this year saw an additional 3 per cent levy aimed at second and investment homes.
Additional tax of £3,000 for every £100,000 of property value is a significant additional cost for BTL investors, and one that may well negate most of the first year’s rental income.
Income tax
Rental income is taxed as unearned investment income and added to other taxable income in that tax year. Charges for additional services, such as cleaning, provision of utilities, rent of furniture, etc, are also treated as rental income.
Rental income is subject to tax at 0 per cent, 20 per cent, 40 per cent or 45 per cent depending upon which tax band or bands it falls into, after the deduction of allowable revenue, not capital, expenses. For example, general maintenance (but not home improvements), insurance, managing and letting agent fees and interest on a mortgage used to buy the property are all permitted expenses.
In many cases, the expenses match or even exceed the rental income, especially during void periods, so in practice the full rental income is not subject to tax.
However, expenses are expenses: they are not money which can be kept or used to supplement other income.
April 2017 change
A change to a tax relief affecting some BTL landlords was announced in the Summer Budget 2015. From April 2020, tax relief on property loans for residential property will be restricted to the basic rate only (20 per cent). This will be phased in over four years from 6 April 2017 onwards.
This higher-rate tax change has another sting in the tail. As well as mortgage costs, there are others, which include the costs of obtaining finance, such as fees and commissions, certain legal expenses and any valuation fees required to provide security for a loan.
Capital gains tax
Capital gains tax (CGT) is not the property investor’s friend. Rising asset values and no realistic opportunity to spread gains over multiple tax years make realising chargeable gains a binary, all or nothing decision. Since taper relief was abolished in April 2008, after that method took over from indexation in 1998, investors also face paying CGT on inflationary gains.
The situation has worsened though following this year’s Budget, via plans to reduce the rate of CGT for most investments but not for second or investment properties as of 6 April 2016.
Inheritance tax
The inheritance tax (IHT) position with buy-to-let property has not changed. However, the way IHT is charged on the main residence will change. This is of relevance.
IHT is normally charged at 40 per cent of the value of an estate above the IHT threshold, or nil-rate band (£325,000 for 2016/17). In effect, everyone is a higher-rate taxpayer for IHT purposes. Married couples can pass any unused threshold onto the surviving spouse.
However, for deaths on or after 6 April 2017, a new main residence nil-rate band will also be available in addition to the standard nil-rate band. The main residence nil-rate band will be applied to the net value of the home (for example, after any outstanding mortgage or liabilities), to a maximum of:
• £100,000 for 2017/18
• £125,000 for 2018/19
• £150,000 for 2019/20
• £175,000 for 2020/21
This nil-rate band provides additional IHT relief and the potential for a couple to pass a combined £1 million down generations before the tax is paid.
Although there is no IHT change for second property, the relative increase in the tax efficiency of the home could see more people investing in their main residence as opposed to BTL.
As an investment, BTL is inflexible, expensive, illiquid and can require excessive time and effort to properly manage the people as well as the process. Add deteriorating tax inefficiency relative to other options to that, and it is difficult to put forward a case for the sector as a mainstream investment for most private clients.
Danny Cox is a chartered financial planner at Hargreaves Lansdown
