What do the 2017 buy to let tax changes mean for me?

Today, buy-to-let tax changes come into effect for landlords across the UK. With tenant referencing firm Tenant Referencing UK finding that 7 in 10 landlords are still unaware of the changes, we explain what the new rules mean for you:

What are the new rules?

From 6th April 2017, the UK government is phasing out mortgage interest tax relief for landlords, which will prevent you from deducting mortgage interest payments, or any other finance-related costs, from your turnover before declaring your taxable income. You will then be able to claim back 20 per cent of it as a credit.

Why are they being introduced?

The buy-to-let tax changes are being introduced because of Section 24 of the 2015 Finance Act. The government announced the new rules as part of a series of measures designed to crack down on buy-to-let and ostensibly help to encourage home ownership among first-time buyers. Landlords, though, do not buy the same properties as first-time buyers, while the private rented sector has become an important stop-gap for those who cannot afford to buy a home and need a cheaper form of accommodation. Research reveals that 80 per cent of landlords in the UK own only one property and are amateur landlords. As a result of the rising costs, the Royal Institute of Chartered Surveyors predicts that rents will rise by 25 per cent over the next five years, ironically making the private rented sector more expensive for tenants and making it harder for first-time buyers to get on the housing ladder anyway.

When do they come into force?

The first phase of the mortgage interest tax relief reduction comes into effect as of Thursday 6th April 2017. The amount you can write off will then drop by 25 per cent each tax year until 2020, when you will have to declare all of your rent as income and pay income tax on that.

How much will my buy-to-let returns be impacted?

Your rental income will be impacted more significantly as the tax relief is incrementally phased out. By the end of the four-year period, unincorporated landlords will be taxed on turnover rather than profit – and will instead be provided with a 20 per cent tax credit. Those with the money to pay off their existing mortgage, or large institutional investors, will be favoured by the policy. Smaller landlords, though, will be hit hardest.

An unincorporated landlord who pays higher rate tax will face an effective tax rate of 76 per cent for properties that are 50 per cent funded with a mortgage. 440,000 landlords are predicted by the National Landlords Association to be pushed into the higher tax bracket. As a result, many will find their tax bill outweighs their profits.

Will my buy-to-let property make a loss?

This will depend on your buy-to-let investment. Here are some example scenarios from Hayley Bradfield, an Associate of Cardiff-based Watts Gregory Chartered Accountants.

Under the current rules, a landlord with a £375,000 home generating an income of £350 a week with a 75 per cent LTV mortgage would have a turnover of £18,200 a year. Allowing for £5,000 expenses, and deducting the mortgage interest of £9,140, the profit is £4,060, incurring a tax bill of £1,624 – and a final take-home sum of £2,436.

Under the new rules, the same landlord would not be able to deduct their mortgage interest, instead declaring £13,200 revenue. Even taking into account the 20 per cent tax credit (£1,828), the final tax bill would be £3,582, taking the effective tax rate from 40 per cent to 80 per cent and cutting the take-home earnings from £2,436 down to £608.

A landlord with a larger portfolio of 10 similar homes would end up paying more than 100 per cent tax, effectively leaving them making a loss of £4,450 every year.

How can I avoid the new landlord tax?

Landlords who are incorporated and operate as a limited company will not be affected by the new tax rules. Unincorporated landlords have two main options: increase the rent for tenants, passing the cost on so that they do not make a loss, or consider selling a property entirely. (The ensuing reduction in supply of rental properties will also have the effect of causing rents to rise.)

Landlords continuing to invest in buy-to-let property can minimise the impact of the tax changes by focusing on areas with the strongest rental yield to help maximise initial income, as well as buying rental property in the cheapest areas of the UK. Approaching the market on a long-term basis, investing to benefit from capital growth as well as rental income, will help to make for a more manageable investment. Some lenders have introduced cheaper buy-to-let mortgage products to compensate for landlords’ climbed expenses. Buying a property outright without a mortgage, meanwhile, will also avoid being impacted. Read our guide: How to beat buy-to-let tax changes

Should I incorporate as a company?

According to the NLA, a growing number of landlords are choosing to incorporate in anticipation of the new tax rules. Incorporated landlords will only have to pay a flat rate of 20 per cent corporate on their profits. However, doing so can be costly and may not be suitable for your situation. For more, see our full guide: Should I incorporate to avoid the Tenant Tax?

Is there any chance of the law being changed?

The law has been strongly opposed by the private rented sector, with landlords across the UK joining together to mount a legal challenge against the Finance Act. A petition for a judicial review of the law, however, was denied last year at a court hearing.

Steve Bolton of the Axe the Tenant Tax campaign says: “There is nothing fair about introducing retro-active tax changes that penalise small landlords while protecting large investors. Increasing rents in the private rented sector hit some of the most vulnerable people in our society – those ‘just about managing’ ordinary working people that the Government wants to help.”

However, since the change of government in 2016, a U-turn has been announced a new policy that would have increased National Insurance for self-employed people. As a result, there is hope among some in the industry that a similar U-turn could be on the cards for mortgage interest tax relief.

Is buy-to-let still worth it?

Buy-to-let property remains a fundamentally strong asset, simply due to the ongoing shortage of supply in the face of high demand from tenants. Demand for rental accommodation has risen 10 per cent in the last year, according to the Association of Residential Letting Agents. As a result, rent hikes continue, which means that you can still expect a healthy yield from your property.

The question, rather, is whether the financial rules around buy-to-let property are worth it. You will also need to take into account other increased costs, including the 3 per cent stamp duty surcharge introduced in 2016 and the possible ban on letting agents fees announced by the government, which will likely see the fee passed on to landlords. If you are entering the sector, make sure you do your research to make the best possible investment. (See our guide: What is a good yield on buy-to-let property?)

Where are the best places to invest?

The Northern Powerhouse is increasingly one of the strongest markets for buy-to-let investments, as the UK’s regional economies grow, encouraging population expansion, and house prices remain significantly more affordable than London. HSBC has identified Manchester, for example, as one of the UK’s top four buy-to-let hotspots in the UK, with Jones Lang LaSalle projecting that property prices there will rise by 4.5 per cent per year over the next five years.

View current buy-to-let opportunities in the UK