What Do Tax Relief Changes Mean for Buy-to-Let in 2017?
2016 left the buy-to-let industry shaken by a 3% increase in stamp duty. Though still adapting to those adjustments, the UK’s buy-to-let landlords are facing further challenges in 2017, and should prepare for tough affordability checks and new income tax relief restrictions.
Lenders to Tighten Affordability Assessments
In a move to “bring all lenders up to prevailing market standards”, the Bank of England’s Prudential Regulation Authority (PRA) has announced tighter regulations for lenders who supply mortgages to buy-to-let investors. The new affordability assessments require lenders to consider borrowing costs and possible future interest-rate changes. This will ensure landlords are able to cover the costs of their mortgages, even in the event of increases.
Following the implementation of these stricter standards, it is expected that the number of new mortgages approved for buy-to-let investors could fall by 10-20%.
Loss of Buy-to-Let Tax Relief
New taxation rules relating to buy-to-let mortgage interest are likely to have the greatest impact on landlords in 2017. Currently, landlords receive tax relief on their mortgage interest, with potential savings of thousands each year. When determining taxable profit, landlords can deduct mortgage interest and other associated costs. On that profit, they are taxed generally – from 20% to 45% – depending on their total income.
The new measures will prevent applicable landlords from utilising their entire mortgage interest for taxation purposes. Tax relief will then ultimately be calculated at a flat rate of 20 per cent.
To illustrate how the change will affect landlords, let us imagine a landlord receives £10,000 a year in rental income, with a mortgage-interest cost of £8,000, which leaves £2,000 profit.
Currently, a basic-rate taxpayer would pay 20% tax on that £2,000 profit – which in this case would be £400, leaving £1,600. A 40% taxpayer, on the other hand, would pay £800, leaving a profit of £1,200.
After all the changes, the 40% taxpayer will pay 40% on the whole £10,000 of rental income (£4,000), minus 20% of the £8,000 mortgage-interest cost (£1,600), which leaves £2,400. This is a £1,600 increase on what the landlord would have previously paid, and could therefore render their investment not economically viable. For a 45% taxpayer, the increase in tax will be even higher.
The system will be phased in over a four-year period that starts this April. For further information about how the new measures will be implemented, visit gov.uk.
According to Nationwide Building Society, it is predicted that some landlords may see their net profits more than halved as a result of the new system, with those paying higher interest taking the greatest hits.
A Silver Lining
Landlords who are in the lower bracket of income tax will find the playing field levelled, as they will no longer be at such a great disadvantage to larger property investors. A hit to the buy-to-let industry may also see homebuyers reaping the benefits of less competition on the property market, leading to lower house prices.
How Can You Tackle Tax Relief Changes?
In a survey carried out by Mortgages for Business, 60% of landlords admitted that they were worried about the effects of new tax relief rules on their profits. If your income – either from property alone, or combined earnings from property and other sources – takes you above the lower income tax brackets, it is important to be prepared in time for April.
The survey revealed that landlords are favouring incorporation to avoid income tax, with 32% owning at least one property through a limited company. Lenders are generally less inclined to approve mortgages for companies than individuals, but landlords will only pay corporation tax – rather than income tax – for properties in a limited company's portfolio, and are still able to deduct the mortgage interest from its income. However, further tax may be incurred on an individual basis if the monies are withdrawn from the limited company.
Another option may include transferring ownership of a property to a spouse or family member – therefore dispersing the income to avoid moving up a tax bracket – this methodology may have drawbacks.
Seek Professional Advice
11% of landlords are concerned that they do not yet know to what extent the changes will impact on their income. To avoid sudden loss of income and to ensure you are prepared for April, you may need to seek professional advice.