Danby Bloch: Osborne’s buy-to-let tax grab a blow to investors

Danby Bloch white

Buy-to-let is under attack by the Government. Indeed, the Chancellor clearly thinks the current rules are too generous, particularly for higher rate taxpayers. Two major changes were announced in the summer Budget which could potentially have a dampening effect on the market.

Buy-to-let has proved to be an attractive way to build up assets for retirement. Partly, this is because the inadequacy of supply of properties (especially in London and the South-east) has underpinned the market.

But the tax system has also provided a terrific boost. Property for let is pretty much the only investment available where you can borrow to invest and get full tax relief on the interest. In theory at least, you can buy a property largely with borrowed money and the rent will more or less cover the interest, with no tax to pay on the rent as a result.

The Government has decided this is too good to leave alone. The biggest blow to investors is the decision to limit the tax relief for interest on loans for residential property businesses carried on by individuals, partnerships and limited partnerships. That will cover a wide range of finance costs beyond interest. However, in practice, it will mainly affect the interest on loans to buy property for renting.

The proposed new restriction will not apply to businesses carried on by companies, nor will it affect “furnished holiday accommodation”.

Tax relief on interest will be limited, in effect, to basic rate tax. To allow landlords to adjust, the change will be phased in over three years, starting in April 2017. The new treatment will affect a quarter of an investor’s interest payments from April 2017, a half from 2018 and three quarters from 2019.

Strictly speaking, there will be a disallowance of the interest payments in computing the taxable profits of the letting business. Then there will be a tax “reduction” that will be broadly equivalent to tax relief on the interest payments at the basic rate.

For example, in a year in which the new regime is fully functioning, Mike has a rental income of £30,000 and allowable interest of £20,000. He is a 40 per cent taxpayer on all this rental income. Under the current rules he has £10,000 (£30,000 – £20,000) taxable income and so a tax liability of £4,000. Under the new rules after 2020 he will have a taxable income of £30,000, on which his tax liability will be £12,000 less a reduction of £4,000 (that is, 20 per cent x £20,000) = £8,000.

A point to watch out for: the increase in taxable income under the new rules (even though the tax itself is diminished by the 20 per cent reduction) will push a fair number of basic rate taxpayers into higher rate tax.

This new system will introduce some extra complications, notably when a taxpayer is not able to use the new tax reduction relief in the relevant year, for example, because the rental business incurs a loss and the tax reduction has to be carried forward to future years.

Lots of buy-to-let owners are already thinking about incorporation and advisers could be asked what they think of the idea of running a letting business through a company.

On the positive side, profits in a company are taxed at corporation tax rates: currently an attractive 20 per cent and due to fall further. But there are downsides. For starters, there is the new dividend tax that will kick in in April 2016. Higher rate and additional taxpayers will benefit from the new £5,000 tax-free dividend allowance but, above that, all taxpayers will be subject to an extra 7.5 per cent tax rate on their dividends.

Then there is the capital gains tax position. There are effectively two layers of tax on capital gains: first in the company and then on the disposal of shares in the company. And as companies are immortal, the effective freedom from tax on the capital gain that applies on death to an individual who owns an asset directly will not apply to corporate assets. Anyone thinking of moving their property empire into a corporate structure will need some pretty switched-on property tax advice about the immediate CGT and stamp duty implications.

The other major change is the abolition of the wear and tear allowance. Landlords of furnished residential accommodation can deduct 10 per cent of the net rent, whether or not they actually spend the money on renewing and replacing furniture and other kit. The proposal is that this should be replaced by a relief for actual expenditure on qualifying furnishings, which will increase taxable income for many people.

Danby Bloch is chairman of Helm Godfrey