How will the changes to property tax affect the buy to let property market?

In recent years the buy to let market has been an attractive investment opportunity for would be and established property investors.

In some parts of the UK, buyers have benefited from rising house prices, increased rents and low interest rates that have made the cost of borrowing and investing cheaper than ever before.

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But, as the storm clouds, from the 2015 Summer Budget, appear on the horizon investors may now find themselves asking, ‘what impact will the changes have on me’?

Our simple guide takes you through the current and future changes, explaining what you need to know and how the changes will affect you.

What do the changes mean?

The tax changes that are coming into force will affect those who own or intend to purchase a buy to let property.

Under the new system the amount you pay when purchasing a property will increase, while the tax relief you can claim falls. With the majority of changes being phased in over a five year period from 1 April 2016, now is the time to act and understand what the implications are, and how they will impact your current or future buy to let investment plans.

What current changes do you need to be aware of?

1 Stamp duty increase

From 1 April 2016, the stamp duty payable on any new buy to let property purchase has increased to 3% above the current rate.

BandOld Stamp Duty RateNew Stamp Duty Rate
£0* - £125k0%3%
£125k - £250k2%5%
£250k - £925k5%8%
£925k - £1.5m10%13%
£1.5m +12%15%

The increase rate will be payable on the purchase of additional properties, including buy to lets and second homes. The considerations around this that you need to be aware of include:

Let to buy: If you move out of your main residence, without selling it and buy another property you will have to pay the 3% Stamp Duty surcharge. However if you sell your original residence within 36 months of completing the purchase you will be eligible to receive a full refund.

Granny annexes: If the house you are buying has a granny annex in most cases you won’t have to pay the extra 3% stamp duty. However you will be liable for the higher rate, annexes must: 

  • Be capable of being sold separately from the main house
  • Have their own entrance
  • Have their own water and electricity supply
  • Receive their own Council Tax bill
  • Be worth more than £40,000 on their own 

2 The abolition of the wear-and-tear allowance

From 1 April 2016, the Wear and Tear Allowance (WTA) has been replaced by the Replacement Furniture Relief (RFR). Currently, landlords of fully furnished properties can claim an annual deduction based on 10% of their rental income.

This compensates them for the replacement of furnishings and is provided even if no purchases are made throughout year. As the old Wear and Tear Allowance was based on rental income, landlords receiving higher rents received an unfair advantage.

Under the new Replacement Furniture Relief, landlords can only claim for the actual cost of replacing furnishings. This covers moveable furniture, such as televisions, carpets, curtains, fridges and crockery. But items such as fitted units, baths, kitchens and boilers aren’t covered.

What future changes do you need to be aware of?

If you currently own a buy to let property you’ll know that the income you receive as rent is taxable. You need to declare any rent you receive as part of your Self-Assessment tax return. 

The tax on your income is then charged in accordance with your income tax banding 20% for basic rate taxpayers, 40% for higher rate, and 45% for additional rate.Under the current rules you can reduce the tax you have to pay by deducting certain ‘allowable expenses’ from your taxable rental income. Allowable expenses include, mortgage interest, mortgage fees and interest on loans used to furnish a property.

The changes announced in 2015 will gradually restrict the tax relief all landlords receive to the basic rate of 20% and from April 2020, landlords will no longer be able to deduct the cost of their mortgage interest from their rental income when calculating their taxable profit.

The rules are being phased in over 4 years commencing April 2017. Under the new measures the tax relief landlords receive at the basic rate of 20% will gradually decrease. After that date landlords and individuals with a buy to let property portfolio will no longer be able to deduct the cost of their mortgage interest from their rental income when calculating their taxable profit.

How will the changes affect your situation?

As an example a higher rate taxpayer who pays 40% tax with a rental income of £15,000 and a mortgage interest of £10,800 (66% of rental income) will see their profit fall from £2,520 in 2016/17 to £360 in 2020/21.

Below is the worked example of how this relief will be phased in:

 As NowTransitional Rates  New
 2016/172017/182018/192019/202020 onwards
Rental income£15,000£15,000£15,000£15,000£15,000
Mortgage interest£10,800£10,800£10,800£10,800£10,800
Reduction in mortgage interest allowance0% = £025% = £2,70050% = £5,40075% = £8,100100% = £10,800
Total rental income on which tax is paid£4,200£6,900£9,600£12,300£15,000
Tax at 40%£1,680£2,760£3,840£4,920£6,000
Allowable tax relief at basic rate (20% of the annual mortgage interest)0£540£1,080£1,620£2,160
Total tax payable£1,680£2,200£2,760£3,300£3,840
Profit £2,520£1,980£1,440£900£360

Representing a total loss of £2,160*

*2016/17 vs 2020/21

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