Buy to Let: Just how much will the tax changes cost you?

Posted on September 28th, 2016 | Categories - Buy to Let

taxBuy to let has probably never been more popular, however it is about to become far less profitable for many landlords.

The Government has made major changes to the way in which buy to let landlords will be taxed in the future. For many, this will mean their tax bills rise. In fact, some landlords could end up paying tax even when they have made a loss.

Currently, buy to let landlords can offset a variety of expenses when calculating their taxable profit. Examples include, agent’s fees, insurance, maintenance cost and, crucially, mortgage interest. It is this last item which is usually the largest single expense for most landlords. It is the practice of deducting mortgage interest, from the rental income, to calculate the taxable profit, which the Government intends to curb.

The new rules will affect higher rate taxpayers, as well as basic rate taxpayers who are pushed into the upper bracket because of their rental income. To give landlord time to prepare the changes will be phased in between 2017 and 2020.

Research from Smith & Williamson has shown that higher rate taxpayers, who have buy to let mortgage interest payments above 75% of their rental income, will see their entire returns wiped out by 2020. It is therefore no surprise that for many landlords, the new rules could significantly reduce the attractiveness of this type of investment.

How much will it cost?

Using the calculator built by Telegraph Money we have considered three simple scenarios to assess the impact on:

  • A basic rate taxpayer
  • A basic rate taxpayer, earning a salary of £40,000, who is pushed into higher rate tax because of their rental income
  • A higher rate taxpayer

We needed to make some assumptions when calculating the figures:

  • For the sake of simplicity, we have assumed that the individual only has income from their buy to let property and their employment
  • We have also used the average rental price of a two-bedroom property, the type typically bought by investors, which was £703 per month in September (Source: Landbay)
  • We have assumed annual expenses, excluding mortgage interest payments, equal to 20% of the rental income
  • Finally, we have assumed that mortgage interest equals 50% of the rental income

All figures have been rounded to the nearest £100.

So what’s the affect in each scenario?

A basic rate taxpayer:

BTL Calc 1

This demonstrates that a basic rate taxpayer, who remains so when their employment and buy to let income are added together, will be no worse off after the changes.

A basic rate taxpayer, earning a salary of £40,000, who is pushed into higher rate tax because of their rental income:

BTL Calc 2

The figures now show the additional tax starting to bite.

A profit which was £2,016 per year, after tax in 2016/17, will be cut by approximately £750 when the changes come into full effect.

A higher rate taxpayer:

BTL Calc 3

The full effect of the changes now becomes apparent with the higher rate taxpaying landlord worse off by around £850 each year.

However, if the same landlord were to be paying mortgage interest of £6,300, equivalent to 75% of the rental income, he or she would actually make a loss of £1,008 after tax, when before they were making a small profit.

Should landlords be worried?

That depends on your own individual circumstances.

However, it is worth remembering that interest rates are at an all-time low. At some point they will rise again, which will only make the situation worse for landlords.

Furthermore, our earned incomes tend to rise over time, again making the situation worse.

What action should you take?

We would suggest that all landlords carefully calculate the additional tax which will be payable once the changes begin to take effect.

You can click here to use the Telegraph Money calculator, please scroll down towards the bottom of the page.

Once you have calculated the cost of the changes you can start to decide on the best course of action.

During the next few weeks we will publish our own thoughts on the options available to buy to let landlords. In the meantime, if you require advice tailored to your own individual circumstances please Bev or Sarah on 0115 933 8433 or email info@investmentsense.co.uk

We are here to help.

Please remember, the Financial Conduct Authority does not regulate buy to let mortgages

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