Please Note: This Article is 5 years old. This increases the likelihood that some or all of it's content is now outdated.

Viewpoint

It was another Budget in 1988, Nigel Lawson’s, a landmark which kicked-off a new era of renting in the UK. This had followed a 30-year period of decline due to rent controls and lifetime security of tenure for private tenants, meaning that no private landlord in his or her right mind would consider renting out a house.

The 1988 Housing Act’s deregulation of the private rented sector set the market free and it was perhaps not coincidental that a liberated economy, emerging from the strike torn 70s, needed an expanding, flexible and mobile workforce which was suited to rented housing.

Once investors realised the shackles had been removed people started to rent out properties once more, and this included not just the wealthy; the ordinary Joe who had a few bob saved up and a few spare hours to spend at weekends hanging wallpaper could participate. The rental market blossomed and the rest is history.

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The introduction of the Buy-to-Let (BTL) mortgage in the 1990s really gave the industry a boost, as then landlords could borrow at rates which equated more to a homebuyer mortgage. Up until that time investor landlords had had to use a commercial mortgage, at punitive rates of interest. As the mortgage industry learned that landlords were no riskier than the average homeowner, in fact on average less, the mortgage industry expanded offering the really competitive rates we see today.

Fast forward 25 years, and following the ups and downs of the property market through the worst economic recession in living memory, we have a UK rental market of unprecedented size: over 2m landlords, 9m tenants, buy-to-let mortgage debt running at £200bn, close to Greece’s national debt, and something of a price war between lenders.

With the issuance of buy-to-let mortgages outpacing homebuyer mortgages over the last 12 months it’s perhaps not surprising the Chancellor and the Bank of England (BoE) were getting concerned that the level of outstanding debt lent on housing, coupled with inevitable interest rate rises, could once again destabilise the banks.  A recent BoE report has said that BTL landlords are the most vulnerable to an interest rate rise. So, a rush for the exit by buy-to-let landlords would result in a house price crash, leaving thousands in negative equity.

The Summer Budget arguably sought to slow down BTL growth by tightening tax relief for landlords, and suggestions that the buy-to-let mortgage which, unlike the homebuyer mortgage, is unregulated, could have tighter lending criteria imposed.

So, is all the media hype we have seen around these measures justified? Will they be sufficient to kill-off BTL? I really don’t think so. Some will undoubtedly be worse off, particularly those high rate taxpayers with large portfolios and a considerable amount of debt. But holiday lets and commercial properties are unaffected and some may consider reducing debt by selling of a property or two.

If you are relying on interest rate relief for a mortgage or mortgages, and you remain a basic rate taxpayer, there will be no change. Where the allowance changes push you into the higher rate band then clearly you will pay more tax. High rate taxpayers will pay more tax from April 2017. The changes will impact those with large highly geared portfolios the most, and in those cases they may need to consider reducing debt and/or incorporation.

BTL is now a huge industry in the UK, so much so that it is attracting the attention of some corporate investors and wealth funds, encouraged by government funding and tax incentives. The private landlord has had the market pretty much to himself, but perhaps not for much longer. Large scale professionally managed rentals, appointed and equipped to very high standards, will target a higher end segment of the lettings market.

These developments are unlikely to have a dramatic affect on the 70% or so of small-scale landlords with just one or two rentals, in the short term, but they will be encroaching at the edges. Competition is a good thing to improve standards, and if it has that effect it will be welcomed by tenants, many of whom do live in sub-standard accommodation.

Prior to the election in May BTL landlords faced a barrage of bad publicity. Some was perhaps justified, most not, much of it generated by charity campaigning groups and left wing politicians highlighting the antics of a minority of rogue landlords. Much though through envy and jealously of what they saw as “millionaire” landlords getting unfair tax breaks. Perhaps this prompted the Chancellor’s kerbs on mortgage interest relief, I don’t know, but kerb them he did.

As some 25 per cent of Conservative MPs and 20 per cent of all MPs are landlords, it’s perhaps a brave move on the part of George Osbourne to “create a fairer housing market” as he put it, by reducing the tax benefits landlords have come to expect.

Some argue that as a business BTL should naturally receive the same tax relief benefits as any other business loan, in order to encourage investment. But BTL has never had full business status in the eyes of HMRC, being classed as an investment, albeit with some generous allowances, plus BTL operates in a highly emotive area: housing, where public opinion matters.

Although some of the wealthier large portfolio landlords will feel the effects of the Budget changes most, not all landlords will be affected. For a start, not all landlords have mortgages, and of those that do a large proportion will be small mortgages. On the wear and tear allowance, more and more properties are let part-furnished which prevents the 10% charge in any case.

Following the Summer Budget 2015, providing these are all passed into law, which is pretty certain, landlords will only be able to claim 100% tax relief on mortgage interest and finance costs up to and including 5th April 2017. After this, relief will be allowed at 20% of a sliding scale, 75%, 50% and 25% until after 2020 the maximum allowance will be just 20% or the basic rate of tax.

The wear and tear relief, which currently gives a 10% annual allowance for those landlords letting fully furnished accommodation, will be abolished after 6th April 2016. This will be replaced by a one-for-one furniture and furnishings replacement scheme to bring BTL into line with holiday rentals.

Some have suggested that incorporation (forming a BTL limited company) may be the answer to getting around the allowances cuts. This move is unlikely to benefit the small-scale BTL landlord, not lease because selling privately owned properties to a limited company would most likely lead in immediate capital gains tax liabilities. It may well benefit larger landlords when entering into new developments. Small-scale landlords should consider transfers of ownership between spouses to maximise tax allowances.

Tom Entwistle

Please Note: This Article is 5 years old. This increases the likelihood that some or all of it's content is now outdated.
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8 COMMENTS

  1. Your reporter assumes that the 20% Relief on Buy to let is the maximum the Chanceller will reduce it to. I think it is just the beginning and they will eventually reduce it to 0% relief.

  2. I think the reporter has VASTLY under-estimated the effects of this change in tax. At best it will cause a massive hike in rents – the general consensus is 30% over the next 5 years. The Bank of England has said the change will only affect 1 in 5 Landlords but so far has not responded to calls to explain how they got to that figure. Let\’s assume though that this means 1 in 5 will be badly hurt and have to take action.

    There are 2 million private landlords in this country so 1 in 5 = 400,000. If they each, on average, only sell off 2 properties then that\’s 800,000. That also means 800,000 evictions of tenants, and if each of those tenants is a family of 3, then it means 2.4 million people will be made homeless, plus of course some of the Landlords that will, inevitably be made bankrupt, as it is highly possible that they\’re paying more in tax than they make as income. Yes that is entirely possible!

    Sign the petition at https://petition.parliament.uk/petitions/104880. It\’s nearly up to 5000 people now.

  3. Has everyone forgotten the private social landlord, these landlords who keep a good house, only rent to those on HB due to their sense of moral fibre. Introducing a social landlord (private market) governed by LA housing standards should be supported with tax reliefs as they are offering a service to the much needed housing crisis in which LA\’s relying upon their support with their own housing needs.
    Is this the future of housing needs in the social sector?

  4. Tom Entwhistle\’s article could just have easily come from the treasury P.R. department rather than from a forum that looks to support the industry.
    Landlords and property professionals.operate as sole traders and incur costs in the course of running their business. The planned restriction will unfairly target Landlords by preventing them from offsetting costs in the same manner as other sole traders. The Institute for Fiscal Studies has stated, in response to the Budget, that individual landlords are already taxed more heavily than other homeowners.
    The ability to offset finance interest as a cost before calculating profits and therefore any tax owed is quite normal in business. The general taxation principle is that tax is applied on profit. What Mr Entwhistle seems to have skirted around is a fundamental shift in the conventions on taxation.The proposed changes to the allowances on taxation for Landlords who bought in their own names will mean that they will have to pay tax on their buy to let mortgage interest expense rather than on the real income they generate. Mortgage interest is a legitimate cost of the business just as it is for any other form of enterprise in the country which borrows money to buy assets that generate taxable income. This could be the beginning of some new convention on taxation, that\’s why it should be vigorously opposed. The unintended consequences have yet to be seen, but many Landlords will sell out, many will also raise rents. I expect a glut of properties to flood the market in around 2018/2019, with higher rents making it much more difficult for the tenant, and first time buyers will still be unable to pick up on the available housing stock due to MMR and higher interest rates.
    Wasn\’t Osbourne seen crying at Margaret Thatcher\’s funeral? Wasn\’t she a hero of Osbourne? Didn\’t she suggest that you can\’t buck the market? Well, that\’s what Osbourne is trying to do…

  5. As a private landlord for 14 years, I have never before put up rents for a sitting tenant. In addition, my rents have risen at well below either the CPI or RPI over those 14 years. In the light of this budget, I\’m now going to start increasing the rents by the CPI each year as allowed for in my tenancy agreements.
    So any advice to the chancellor that says the effects would not include any rent rises is just plain wrong.

  6. This is direct from Megan Shaw Product Owner HMRC, contact details are on the bottom so this can be confirmed very quickly should you feel it is incorrect.one

    Observations from this very simple example below we can see that :

    1. A 20% tax rate payer is pushed into the 40% band with the new proposals
    2. The taxable property profit Of £1,200 will be deemed by HMRC to be £12,000
    3. The “real profit” of £1200 was initially taxed @20% making tax due £240
    4. The tax payable increases by £1800 making a total of £2040
    5. The tax liability completely wipes out the profit and leaves a further liability of £840. 6. In percentage terms £2,040/£1,200 x 100 is 170%, the effective rate at which tax will be paid.
    7. This simple model is no longer viable, the landlord must sell up, pay down borrowings or increase rent.

    Example:

    Prop rental income is £15,300, or £1,275 pcm (a 3, 4 or 5 bed HMO maybe depending on location)
    Prop Val £275K
    Expenses: 10% agent fees (£1,530) and a few repairs, gas safe, insurance etc =£3,300
    Finance on a loan of £216k (78.5%LTV) @ 5% = £10,800
    Net profit £1,200

    These figures are very realistic and common place for individual Landlords, this example represents a large number of landlord positions.

    If the landlord had a second property, also with a profit of £1,200, his tax in 2020/21 would go up by £2,640 compared to his liability if he only had one. The effective tax rate on this second property would be £2,640/£1,200 x 100, or 220% of the rent.

    Under the current system this landlord would have remained a basic rate taxpayer even with 2 properties. Under the proposed system he will very much be a higher rate taxpayer.

    After April 2020 (when the restriction will be fully implemented) landlords who incur interest (and other associated finance costs) on residential properties that they let will need to calculate their tax differently. You will no longer be able to deduct interest from your rental income to arrive at your taxable profits, you will instead receive a reduction from your income tax liability equivalent to 20% of those interest costs. If that means you become a higher rate taxpayer (or you were anyway) then you will have to pay more tax as a result of this change.

    Please see the example below. This comparison is designed to show the effect of the change, not to calculate someone’s exact tax liability. The tax bands were rounded off for simplicity, and applied to both years so as not to confuse the result of the calculation.
    Before restriction 2016-17 £ After restriction 2020-21 £
    Salary 40,000 Salary 40,000
    Property income 15,300 Property income 15,300
    Less Other costs (3,300) Less Other costs (3,300)
    Less Finance costs (10,800) Less Fin costs (0)
    Property profits 1,200 Property profits 12,000
    Taxable income 41,200 Taxable Income 52,000
    Less Personal Allowance (11,000) Less Personal Allowance(11,000)
    Tax due on 30,200 Tax due on 41,000
    Tax at 40% 3,600
    Tax @ 20% 6,040 Tax @ 20% 6,400
    Total Tax 6,040 Total Tax 10,000
    Less Finance Costs @ 20% (2,160)
    Final Tax 6,040 Final Tax 7,840

    Please do get in touch if that doesn’t clarify the mechanism.
    The Bill is subject to parliamentary scrutiny and so there are no guarantees as to what will become law before the Bill receives Royal Assent in Autumn.
    Megan Shaw
    Product Owner – Property Income & REITs
    HMRC, Room 3/64, 100 Parliament Street, London, SW1A 2BQ
    03000 585628

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