“Osborne drops tax bombshell that will wipe out bulk of buy-to-let profits”, The Guardian, 11th July 2015
The Guardian, like the Financial Times and many other media outlets baulked at George Osborne’s somewhat hidden tax relief changes as announced in the emergency Summer Budget last July. The talk has been of a ‘rental Armageddon’ and the decline of rental properties in the UK.
However, the media can get heated over minor details, and the purpose of this article is to explore the truths and smash those myths surrounding these changes. So let’s look at what happened.
The 2015 Budget has changed the future trading environment of being a residential landlord. The changes to tax relief, buried deep within the Chancellor’s red book, will impact on residential landlords. This article will help landlords, especially landlords with Buy-to-Let (BTL) properties, understand how these changes will impact on their business model.
What’s going to happen? The Chancellor in his Summer Budget announced that “The government will restrict the relief on finance costs that individual landlords of residential property can get to the basic rate of tax. The restriction will be phased in over four years, starting from April 2017.” (Summer Finance Bill 2015).The financial services giant, KPMG, published a detailed paper exploring the tax relief changes and how they could impact landlords. They argued, “Individual owners of residential property are currently normally able to deduct the full interest costs from borrowings in respect of their property business. This is very similar to the treatment of interest paid by trading businesses but in contrast to interest paid on an individual’s main residence where no deduction is allowed for interest paid” (KPMG, 2015).
The changes, which are due to be introduced by April 2017, will be in relation to rises in personal tax earning thresholds. The National Landlord Association argues, “Income tax ‘reliefs’ are to be restricted to the greater of £50,000 or 25% of income as of April 2013” (NLA, 2015). The Residential Landlord Association similarly opined, “The new rules will be introduced gradually over a three year period starting from 6 April 2017, and relief will be available as follows:
- In 2017/18, the deduction from property income will be restricted to 75% of the finance costs incurred, with the remaining 25% being available as a basic rate reduction.
- In 2018/19, 50% of the finance costs will be given as deduction and the remaining 50% will be given as a basic rate reduction.
- In 2019/20, 25% of the finance costs will be given as deduction and the remaining 75% will be given as a basic rate reduction” (RLA, 2015).
Therefore, as outlined by key landlord associations and financial property specialists, these changes will impact on the business model, especially loss-making, that any residential landlord undertakes. However, there is guidance available to help overcome these changes. Let’s explore how landlords can protect themselves from these changes.
So, basically, you are currently allowed to offset the interest you pay on your mortgage each year through your annual tax bill. This is called claiming tax relief through the personal tax rate. However, as outlined above, Osborne’s radical scheme will mean a residential landlord is unable to deduct the cost of their interest from their rental income in line with their tax allowances when they come to calculating their overall profit or loss. KPMG and other financial service providers believe some residential landlords will loose upwards of 100 per cent of their profits in tax whilst some may be paying even more than they have generated in rental fees.
The Government has argued that there is a silver lining in that there is a basic rate relief available to all, at 20 per cent, which they argue will help landlords make a profit. However, this percentile is not enough to protect landlords from rate rises and other supplementary costs. The Government understands the general demographics of landlords, they know that 90 per cent are higher-rate taxpayers and as such have been shielded from earlier rounds of ‘cost cutting’. This is the Government trying to make sure the cuts are fair.
It has been calculated by Smith & Williamson, a tax specialisation company in London that higher-rate landlords with a defined mortgage interest rate of seventy five per cent or above, net of course of all other supplementary costs, will most definitely see all their return on investment obliterated by the end of the roll out in 2020. This means, that approximately 25 per cent of landlords in such circumstances could see no profit from letting out residential property. Considering the massive shortage in housebuilding, the sale of social housing and other pressures on the UK housing sector, this tax change could impact the residential lettings sector with drastic consequences for the millions of hard working families who live in these properties.