Stamp duty rise for buy to let properties and second homes and tax changes for landlords

Over the past years the popularity of buy-to-let properties remained high. Raising property prices, constantly increasing demand for rented properties, and low interest rates all contributed to the popularity of the scheme, allowing more and more landlords to receive profit from their buy-to-let portfolios. However, the upcoming changes might significantly change this situation. The landlords will have to plan in great details their future buy-to-let purchases to increase profit, and avoid likely potential losses.

Recently announced changes will see 3 % charge being added on purchases of additional residential properties above £40,000. 3 percentage points above the current level will be added to every SDLT band, including the previously tax-free element. The changes will take effect from 1st of April 2016.

It means the tax bill on a buy-to-let property costing £450,000 will jump from £12,500 to £26,000. More examples of how SDLT changes will affect buy to let properties and second homes are shown in the table below.

Many landlords are already concerned about diminishing return on buy to let properties, and for some this might be a last drop.

It is already second significant problem that buy-to-let investors had to face in 2015.

In Summer Statement 2015 it was announced that under the changing rules landlords will no longer be able to deduct the cost of the interest on their mortgage from their rental income.  This change will be implemented over a number of years from 2017 to 2020, and it is expected that it will significantly decrease the profitability of some buy-to-let investments, and will even make some of the buy-to-lets loss-making.

For example, if your property earns £20,000 rental income per year, and the interest on the mortgage costs £13,000 per year, you will only pay tax on the £7,000 profit.

That is a tax bill of £1,400 for basic-rate payers (20%), £2,800 for higher-rate taxpayers (40%), and £3,150 if you are an additional rate taxpayer (45%).

Over three years starting in 2017, the amount of mortgage interest tax relief landlords can claim is changing. You will no longer be able to deduct your mortgage interest before calculating your tax bill, and instead will get a tax credit equivalent to 20% basic-rate tax on this amount.

Therefore going back to the example above, under the new rules you will now owe tax on your entire £20,000 rental income. You will, however, get a 20 per cent tax credit for the £13,000 interest element, giving you back £2,600.

So, basic-rate taxpayer will still have to pay the same amount of £ 1,400 (£20,000 * 20%  - £2,600). But if you are a higher rate taxpayer, you will eventually have to give the taxman £5,400, and additional rate taxpayers would hand over £6,400.  

Subsequently, interest rates wouldn’t have to move far before higher and additional rate taxpayers would be left making no money at all after tax.

From the first sight, the basic-rate taxpayers seem unaffected. However, some basic-rate taxpayers will also pay more tax – because the change will push them into the higher-rate bracket, automatically increasing the amount of tax from the same level of income as they had before.

These changes in Stamp Duty will most definitely affect the real estate market, as the potential investors may re-evaluate the attractiveness of residential property investments.

In the short-term period prior to April 2016 it may however cause brief price increase in investment properties, as some investors will rush to buy before new tax changes take effect in April 2016. 

Intentions of the government

The changes are designed to adjust the unequal competition between investors and first-time buyers.

Delivering his Autumn Statement 2015, George Osborne said: “Frankly, people buying a home to let should not be squeezing out families who can't afford a home to buy. So I am introducing new rates of stamp duty that will be three per cent higher on the purchase of additional properties like buy-to-lets and second homes.”  He said “more and more homes are being bought as buy-to-lets or second homes” and “many of them are cash purchases that aren’t affected by the restrictions I introduced in the Budget on mortgage interest relief; and many of them are bought people who aren’t resident in this country”.

This situation resulted into fierce rivalry between professional investors benefiting from buy-to-let properties, and buyers trying to get on the property ladder and purchase their first (owner-occupied) home, and also triggered sharp increase in the number of people renting properties in the private sector over the past years. 

Lawmakers hope to reduce the attractiveness of buy to let properties to investors, which as a result shall make properties easier to acquire for the first time buyers and owner-occupiers.

The funds raised by the increase in the property tax will fund increased house building as Osborne focused on boosting the supply of housing and making it affordable to buy.

The plan is to build 400,000 affordable new homes by the end of the decade, which would not just be affordable to rent, but affordable to buy. Half of the properties will be starter homes sold at a 20% discount to market value to young first-time buyers, and 135,000 will be Help to Buy shared ownership properties.

What to expect

The announcement of Stamp Duty increase has been harshly criticized by many industry professionals and obviously many landlords, with some calling the change in tax “catastrophic news for the private rental sector”. To keep buy-to let investments profitable, landlords will have to pass the burden of an additional tax on their tenants, which will drive up the rents and decrease the standards of the rental properties. The rents will also go up as landlords will be trying to maintain profitability of their investments when the mortgage interest rates will rise.

It will become more difficult for new landlords to enter buy-to-let market, and already existing gap between supply of properties and ever increasing demand will widen further. Therefore, increase in rents may also be caused as a result of further shortage of properties available to rent.

On the bright side, it should become easier for many first time buyers to finally get their own place.

Things to consider further

Buy-to-let landlords and owners of the second homes will need to watch out for further clarification of the changes, as it is yet not 100% clear how the announced SDLT changes will be implemented and monitored.  The definition of a “second home” for SDLT payment purposes will need to be established in clear terms, as well as what to do in the situation when the buyer has not yet decided how to use the property at the time of purchase. We are also still to see how the definition of the second home will be applied to overseas buyers, who have their main property abroad.

Those who have previously already invested in buy-to-let or second homes in the UK, or planning to do so by taking out the mortgage, will need to carefully recalculate their future returns considering the recent changes in tax, specifically those announced in the Summer Statement, as they might result in significant fall of rental income over the period of upcoming years. However, those who were planning buy-to-let purchase and are able to finance it in cash, shall probably stop procrastinating and act immediately, as from April 2016 buying the same property will already involve additional Stamp Duty expenses.

Effective solutions from Law Firm Limited

Recently the tax situation has been rapidly changing in the UK, and it is crucial to take into account and carefully consider tax implications prior to making any buy-to-let or even first-home buying decisions.

As a result of dynamically evolving rules and legislations, previously effective tax solutions might become vain under the current regulations.

Specialists of Law Firm Limited will be glad to help you find new solutions in changing circumstances by developing fresh options, and minimising negative effect of any recent changes on your investments.

The recent changes of SDLT for buy-to-let and second homes obviously change the market of residential property investment. Every case of the property purchase, including buy-to-let, is different, and our specialists will evaluate each separate case for the prospects of future profitability with a help of long term financial planning and professional tax advice. 

We will be glad to consult you regarding matters of property purchase and investment, advise with tax planning solutions, and develop individual effective solution which will work for you.