Death Of The Buy to Let Market?

Death of the Buy to Let Market? 

It appears that the Chancellor has a very clear desire to significantly dampen down the buy to let market.

Why would that be?

Evidence seems to support the fact the buy to let buyers are inflating property prices, particularly in the price range that would attract first time buyers and the government are very keen to help people making their first steps onto the property ladder. Therefore, steps to deflate the market have lots of merit in the government’s eyes. This does however overlook the fact that the buy to let market satisfies a significant need for those who simply can’t save enough to put together a deposit as well as those who may struggle to get a mortgage.

So what has happened?

Over a 4 year period from 6th April 2017, higher rate tax relief will be phased out in respect of mortgage interest on buy to let properties.

In addition, a valuable tax relief called “Wear & Tear Allowance” is being abolished with effect from 6 April 2016. It will be replaced by allowance for actual costs incurred so it makes sense to defer spending on replacement items until after 6 April 2016. It will also be important to maintain records to show that any spend was a replacement item and not an improvement as there will be no relief on improvements.

Didn’t I hear something about Stamp Duty?

Yes, the Chancellor, recognising that the above changes don’t deter cash buyers, has introduced a new Stamp Duty charge that is 3% higher than existing rates on purchases of 2nd homes costing more than £40,000 after 6 April 2016. Someone purchasing a buy to let home for £275,000 would see their Stamp Duty cost jump from £3,750 to £12,000!

What is the impact of the removal of higher rate tax relief on interest charges?

For buy to let investors with one or two properties who rely on the income it will be significant! In example 1 below we can see that a net profit, post tax, of £720 turns into a loss of £280.

For investors with significant portfolios and high gearing it could be devastating, turning a reasonable investment return into a significant loss and rendering the business in that form completely unviable. We can see this very clearly in example 2 below.

Perhaps more importantly we also need to consider the impact of rising interest rates over the years ahead. The examples all assume that interest rates remain at current levels but the impact will be magnified when interest rates inevitably start to rise.                   

Example 1 also assumes an interest rate of 5% but this could well be lower than current market rates for buy 2 let investors.

It has been suggested that the impact could be covered by increasing rents but that would seem to have its limits that will be set by how much tenants are prepared to pay. It could also be argued that rents are already at fairly high levels due to demand.

Example 1:

Jo a 40% taxpayer has a Buy 2 Let property with a mortgage of £100,000 and Interest on the mortgage of £5,000 pa.

 

2016/17

2020/21

Gross Rents

7,200

7,200

Repairs and other tax allowable costs

1,000

1,000

Interest on Mortgage

5,000

-

Net rental profit

1,200

6,200

Tax at 40%

480

2,480

Less Interest relief at 20% on £5,000

 

(1,000)

Net Tax liability on rental income

480

1,480

Tax Increase

 

1,000

Effective rate on “real rental profit”

40%

123.3%

Net Income Return after tax

720

(280)

 Example 2:

John and Julie have a substantial property letting business.

 

2016/17

2020/21

Gross Rents

600,000

600,000

Repairs and other tax allowable costs

200,000

200,000

Interest on Mortgage

350,000

-

Net rental profit

50,000

400,000

Personal Allowances (x2)

22,000

-

Taxable Income

28,000

400,000

Basic rate tax (2 taxpayers)

5,600

12,800

Tax at 40%

-

94,400

Tax at 45%

-

45,000

 

 

152,200

Less Interest relief at 20% on £350,000

 

(70,000)

Net Tax liability on rental income

5,600

82,200

Tax Increase

 

76,600

Effective rate on “real rental profit”

11.2%

164.4%

Net Income Return after tax

44,400

(32,200)

 So, what can we do about this?

There may well be some planning that could help lessen the impact as follows:-

  • Reduce borrowings as quickly as practical.
  • Sell properties where the net returns are no longer viable and minimal capital growth is expected.
  • In example 2, Incorporation into a limited Company could be achievable but with significant hoops to jump  through!
  • Come and talk to MBL about a solution tailored for your needs.