Here's what you can do to mitigate the effect of the new buy to let tax changes
Published on 16th March, 2017
Here’s what you need to do to beat the new Buy to Let tax changes
If you read our last blog then you would have seen 5 useful tips all investors should be doing to to better understand just how the new buy to let tax changes are likely to affect them. In this Blog, I wanted to take a closer look at the measures investors can take to help minimise losses without having to sell their properties. There is no doubt that there’s a lot of uncertainty regarding this subject at the moment and so I am hoping this Blog will help investors identify what they need to do.
From having spoken to numerous investors in the past month regarding this topic there are a few common themes appearing and most investors have decided to one of the following:
Option 1: Re-mortgage your Buy-to-let Property(ies)
With interest rates at a record low more and more investors are looking to re-mortgage securing better rates in the process and negating the effect of the new tax changes. If a buy to let landlord is paying 5pc on a typical £120,000 mortgage, he might currently be earning a rental income of £750 per month or £9,000 annually. After allowing for expenses, agents' fees and mortgage interest he is left with a £612 annual profit after tax, (Source L&C). However, when tax relief is reduced to 20pc that profit turns into an annual loss of £588. By re-mortgaging at, say, 3.79pc with a five-year fixed-rate loan from Virgin Money, he can save £1,452 annually on his interest bill, turning that annual loss back into a profit of £574. Without re-mortgaging, his bottom line will deteriorate further as interest rates rise. Should buy-to-let loan rates reach 7pc by the time that higher-rate tax relief has completely disappeared in 2020, he will be looking at an annual loss of £2,784. The likelihood of being able to achieve the re-mortgage will depend very much on your credit status and to what extent you are already leveraged on your existing properties.
Option 2: Re-mortgage your Main residence and overpay your Buy to Let mortgages
Another option that some of my investors are exploring is the potential of releasing equity from their main residence and overpaying their buy-to-let mortgages in a bid to reduce the tax liability. The Interest rates on your main residence is usually a few per cent lower than with buy-to-let mortgages and there is often the option to fix the mortgage for longer periods typically 5 years as opposed to 2 years with buy-to-let mortgages.
By releasing the equity at a lower rate from your main residence, the idea is that the cheaper money could be used to pay down the debt on buy-to-let properties that as of April 6th, will cost more in tax. It’s a great way to reduce your tax liability however like with each of these options there are considerations.
Firstly, and perhaps rather obviously, you need to have the equity in the property to be able to release it. Secondly, it’s important to first try option 1 above since keeping the debt secured against buy to let properties removes the risk of having to sell your home should you fall into more difficulty in the future. Thirdly it's important to consider the cost of the mortgages. The idea is to replace the expensive debt with cheaper debt, if you are not achieving this then again it renders this process useless. Finally, and perhaps most importantly you need to check the terms and conditions of your existing mortgages. Some buy-to-let lenders restrict the amount which you can overpay mortgages and often have in place rather hefty fees for landlords to do so. It’s important to read all the fine print and make sure that it is still financially viable to carry out this option. The last thing you want to do is put your main residence at risk for no apparent benefit.
Option 3: Transfer your properties into a limited company and purchase all new properties in a limited company
This is perhaps the most popular course of action landlords are taking particularly for new purchases. It may not be common knowledge but limited companies are not subject to any of the new tax changes described above and the reduction in tax relief on mortgage interest does not apply to limited companies. Instead, interest for limited companies is classed as a business expense and fully deductible against income. Companies pay corporation tax at a fixed rate irrespective of the size of the profits. The Corporation Tax rate is currently at 20% reducing to 17% in 2020 which coincides nicely with the end of the phased entrance of the reduction in tax relief on mortgage interest. This makes the tax rate very attractive compared to 40% for higher rate tax payers and 45% for additional higher rate taxpayers.
Again, however, there are considerations that will affect landlords differently. In my experience, I would certainly say that purchasing new properties through a company could be advantageous and have employed this strategy personally. Providing I keep much of my income in the company and take minimal dividends or directors loans there are benefits.
When it comes to transferring existing properties into a company, however, this does not work for me but may work for others. The reason it doesn’t make sense for me with transferring existing properties into limited companies is because transferring property effectively acts as a new sale of that property consequently triggering both capital gains tax as well as stamp duty and by the tie I have taken this into consideration it does not make financial sense to do so. That's not to say it won't make financial sense for you; it's just given my current portfolio it doesn't work. Again, tread carefully here and employ the services of a qualifies tax advisor to run all of this through with.
Option 4: Sell some existing properties and rejig your portfolio
Whilst we always say never sell, unless you absolutely must, this could be one of those circumstances where you may absolutely must sell to reduce your overall tax liability. Some of our more experienced landlords who own 15+ buy-to-let properties, some of which are unencumbered of any debt, are choosing to sell one or two of the properties they own to then overpay the debt on the properties affected by the new tax changes.
Again, you just need to be careful and make sure you have fully understood the terms and conditions of the buy-to-let mortgages you want to pay down the debt on to make sure it is viable to do so financially.
Option 5: Increase Rents
In all likelihood, particularly those landlords who are less informed, most will adopt to this option to try and recoup some of the funds in light of the new tax changes. I think it’s safe to say that for those landlords that do nothing about the new changes, they will only really have this option available to them. Whilst it is a very viable option landlords need to be careful not to price themselves out of the market with this. Already rents are at the highest they have ever been in the UK, and already we are seeing tenants being pushed to their maximum affordability. You need to always keep an eye out on the competition since if they haven’t increased their rents and you do, the likelihood is it will take considerably longer to rent your property out. After all, void periods are costly, an empty property means an empty pocket. Similarly, if you choose to raise the rent for existing tenants then could they find a better option elsewhere? All of this needs to be considered before raising your rents. If you can manage to do so without upsetting the tenant too much, then it can be a viable option.