15 October 2015

Buy-to-let - is it still worth it?

We question whether buy-to-let is still the investment it once was following significant changes to the tax relief, announced within the Summer Budget.

The Summer Budget brought dramatic changes to buy-to-let tax reliefs, which has left many people wondering whether or not buy-to-let is still worth it. Low interest rates and rising house prices in large areas of Scotland, particularly in Edinburgh and Aberdeen, have seen significant returns for buy-to-let investors. However, this is likely to change following the Chancellor's unexpected intervention. 

Currently, tax relief for buy-to-let is generous, allowing full relief for mortgage interest against rental profits for individuals. Further, for furnished lets, an additional relief of 10% of the rental income is allowed as a 'wear and tear' deduction. This allowance is available irrespective of whether there are any 'wear and tear' costs incurred by the landlord. 

What are the changes?

Following the Budget, however, the buy-to-let tax reliefs have been severely restricted. The 10% wear and tear allowance will disappear from 6 April 2016, and from 6 April 2017, the tax relief available for mortgage interest has been reduced. The new interest rules are being phased in over three years, with the full effect not being felt until the year beginning 6 April 2020. From 6 April 2020, tax relief on the full amount of the mortgage interest will only be available at the basic rate. From 6 April 2017, only 25% of the mortgage interest tax relief will be restricted to the basic rate, increasing by 25% each year. 

The restriction on finance costs is not limited to mortgage interest only. Costs including mortgage arrangement fees and interest on loans to buy, furnishings for example, will also come under the tax relief restriction. 

A practical example...

A very basic example illustrates the tax impact. George is a higher rate tax payer and owns a furnished buy-to-let property with an annual rental income of £10,000. His mortgage interest is £2,500 per annum. 

Before the buy-to-let changes (year ended 5 April 2016)

Rental income £10,000

Less: 10% wear and tear relief

Less: mortgage interest

-£1,000

-£2,500

Total profit £6,500
Tax @ 40% £2,600

After the buy-to-let changes (year ended 5 April 2018)

Rental income £10,000
Tax @ 40% £4,000

Mortgage tax relief:

25% of £2,500 @ 20%

75% of £2,500 @ 40%

 

-£125

-£750

Total tax  £3,125

After the buy-to-let changes (year ended 5 April 2021)

Rental income £10,000
Tax @ 40% £4,000

Mortgage tax relief:

100% of £2,500 @ 20%

 

-£625

Total tax £3,375

As you can see from the above examples, on a relatively modest buy–to-let profit, the increase in the tax liability is significant. This increased tax liability, coupled with the other hoops buy–to-let landlords have to jump through (for example, electrical testing and increased fire safety regulations), has left many wondering whether buy-to-let as an individual is the investment it once was. The new rules do not only affect higher rate tax payers - they can easily push someone nearing the higher rate tax band into a higher rate tax payer.  

The tax relief restriction on mortgage interest does not currently apply to companies, however, we would strongly advise that you seek tax advice before thinking about incorporating a buy-to-let portfolio. 

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