Recent Tax Changes
Up until April 2017 landlords who owned properties in their personal names could deduct both mortgage interest and other allowable costs associated with a let property from their rental income before calculating how much tax is due. This resulted in the income they declared to HMRC being lower than the actual rental income. This allowed many landlords to keep their costs down and kept many in a lower income tax bracket.
But since changes made in the Chancellors April 2017 budget, landlords have begun to see the amount they can write off for tax purposes decline. The 2017/2018 tax year is the first of four transitional years whereby higher rate tax relief on mortgage interest is being faded out. Over the next 4 years tax relief is going to drop by 25 per cent each tax year until 2020 when landlords will have to declare all their rent as income, pay income tax on the total and then claim back for 20 per cent of it as a tax credit.
|Tax Year||Tax Relief on Finance Cost|
Percentage of basic rate tax reduction
The result is that if you are a basic rate tax payer with income just short of the higher rate threshold, your rental income (less allowable expenses, not including mortgage interest) will now be added to the rest of your income to set your highest rate of tax. The tax will then be calculated before the tax credit for mortgage interest is applied. This will push some landlords into higher rate tax, resulting in larger tax bills.
Wear and Tear Allowance
Another change is that from April 2016, the ‘wear and tear allowance’, you used to be able to claim a 10% wear and tear allowance on any properties rented out fully furnished. HMRC’s definition of fully furnished is: “one which is capable of normal occupation without the tenant having to provide their own furnishings or appliances”. This was calculated as 10% of the net rent received. The net rent is calculated as the rental income received, less any expenses which the tenant would be liable for, such as council tax and utility bills.
The new system only allows landlords to get tax relief when they replace furnishings. Instead of claiming a flat rate allowance, you will be able to claim the cost of replacing the furnishings but not the initial cost.
A stress test is how mortgage lenders assess the sustainable affordability of a buy to let mortgage to a potential borrower. As most buy to let applicants will be relying on the rent to pay the mortgage, the buy to let stress test will usually focus on the rent receivable and the interest payable.
In the past, a standard buy-to-let stress test has required that rent received be 125% of the monthly mortgage payment, thus allowing a buffer for any costs or rental voids. The PRA issued new guidelines regarding interest cover ratios (ICR), in many cases, the rent must cover 145% of the mortgage interest payment at a stress tested interest rate of 5.5%. The resultant change has reduced borrowing capacity for a property generating £10,000 rent per annum from £160,000 to just over £125,000.
Lenders in the buy-to-let market have revised their stress tests to take account for the recent tax changes applied to rental income.
In practice, the 145% requirement isn’t set out firmly and the above change doesn’t always apply in the following cases:
- Where the borrower is a lower rate tax payer
- Mortgages for limited companies
- Commercial or semi-commercial property
- Holiday lets
- Any loans with a fixed term of five years or longer
Additionally, on re-mortgages if you took out the original mortgage prior to January 2017 some lenders will underwrite based on the previous criteria as the PRA didn’t want to create mortgage prisoner. However, in such instances you are unable to increase the loan amount.
Since the changes to interest coverage ratios, some landlords struggle to pass the ICR coverage test from the rental income generated by a property alone. As the buy to let affordability assessments get tougher many lenders are looking for ways to assist landlords applying for a buy-to-let mortgage. Top slicing is when the property’s rental income and your own income is used for the affordability assessment. This can be particularly useful for people who pay higher or additional rate tax on their income or for those looking to purchase higher value properties which have lower rental yields.
Changes to Stamp Duty
In the Chancellors 2015 Autumn statement, it was announced that an increased level of stamp duty would be payable for anyone buying an additional property from April 2016 onwards.
Additional properties now attract an additional stamp duty surcharge even if the property won’t be let out. Furthermore, the starting threshold was lowered to just £40,000 so now most additional property purchases attract the additional stamp duty.
|Portion of property price||Buy-to-let stamp duty rate|
Anyone buying a second property that isn’t their main residence will be charged these new rates. This will include holiday lets and buying property for children if the parents leave their name on the title deeds. Stamp duty must be paid within 30 days of completion of the property purchase, this is usually paid by the solicitor on completion. The amount of Stamp Duty paid is deductible from any capital gains you might make when the property is sold.