Image: Lizzie Orme
Property developer, architect and presenter of Channel 4’s The Restoration Man, George Clarke, looks at the pros and cons of buying-to-let
I personally find buy-to-let a difficult subject to discuss, but it is a very important part of the overall housing debate. One could argue that the buy-to-let frenzy is one of the main reasons why the housing market is so over inflated. The more people that buy properties with the intention of letting them out reduces the number of homes available for those who want to be owner occupiers. The demand for home ownership properties soars while the number of available properties, because of the buy-to-let, is reduced, therefore house prices go up. The irony is that the more house prices increase, the more rental prices go up and the more attractive buy-to-let properties become as investments so people keep buying. It is a vicious cycle that continues to fuel the market.
Now, I’m not knocking those people who want to invest in property. Far from it. With property prices rising at an alarming rate and savings accounts paying peanuts, who wouldn’t be tempted to invest in the buy-to-let game? I know so many families, with young kids, who are investing in buy-to-let properties now so that their children have access to a decent home when they are older. All parents (and I’m one of them) realise that they are going to have to provide significant financial support for their kids to have any chance of owning their own home, so you are better to invest in a buy-to-let property now rather than having to buy your kids a home in 18 years time when house prices may have quadrupled. So, I get it. But, with the boom in buy-to-let properties pushing house prices through the roof the government have announced some big changes in an attempt to cool the market.
In the 2015 Summer Budget and Autumn Statement, the Chancellor introduced some changes that will affect anyone buying or owning a buy-to-let property in the UK. The first change is that from 1st April 2016 higher rates of stamp duty will be charged on the purchase of additional UK residential properties. This will be increased by 3% above the current stamp duty rates.
To give you an idea of what this increase means, say you bought a buy-to-let property before the 1st of April 2016 for £500,000 your tiered stamp duty would be charged at 0% on the first £125,000, 2% on the next £125,000 and 5% on the remaining £250,000, which is £15,000 in total. But after 1st April, the rates will be 3%, 5% and 8% respectively, which would generate a stamp duty tax of £30,000. That is a lot of extra money to find.
The second major change, which is far more difficult to explain, involves the amount of tax you pay on the rental income your buy-to-let property generates. At the moment you only pay tax on the rental profit you make from your property. Let’s say your rental generates income of £10,000 per year, while you pay £9,000 in mortgage interest payments per year to your bank. You’ve made £1,000 in profit therefore you only pay tax on that £1,000 based on your personal income tax bracket. So, your tax bill on the rental profit would be £200 if you pay the basic rate of tax at 20%, £400 if you pay the higher rate of tax of 40% and £450 if you pay the top rate of tax at 45%. Make sense? Try and stay with me.
Well, from April 2017 that all changes. When the changes are fully implemented by 2020/21 you will be taxed on the full amount of rental income you generate and you will only be deducted a maximum of 20% of your mortgage interest payments from this new tax liability. So, say you are a higher or top rate tax payer in exactly the same scenario I’ve outlined above, this is what will happen.
In 2020 a higher rate tax payer will be taxed 40% on the £10,000 income, which is £4,000, but will only be able to deduct 20% of the £9,000 interest payments which equates to £1,800. So the tax bill will be £4,000 minus £1,800 which is £2,200. Remember, under the current system a higher rate tax payer currently only pays £400.
The most important thing to remember here is that if you aren’t making a decent profit on your rental income you might actually make a loss because of the new tax laws. Let’s just say, for argument’s sake, that your rental income is close to our figure of £10,000 per year, but your mortgage interest payments are also around £10,000 so the investment is just about covering its costs. You aren’t making any profit whatsoever and under the current tax laws you would break even as you haven’t made any profit so there is no tax to pay. But under the new laws, if you are a higher rate tax payer, you’ll be making a loss due to the tax on the total income. The tax on income would be £4,000 (40%) and you can only deduct £2,000 (20%) of your mortgage interest. So you would still be paying £2,000 in tax even though you’ve made no profit at all that year! You will then be depending on the capital value of the house increasing to cover this loss, but you still have to pay the bill.
I’m sorry that I’ve bombarded you with figures, but it is so important that you understand the maths and take as much financial advice from an accountant as you can before you even think about buying a rental property. With tax laws changing, stamp duties rising and rental incomes fluctuating so much it is vital you don’t get caught out and see, what you hoped would be, a profitable investment turn into a tax nightmare.
For more tips and advice from George, check out his website at www.georgeclarke.com