Many investors are still assessing the impact that recent tax changes affecting buy-to-let property investment will have on their portfolios. These include an additional 3% stamp duty payable on the purchase of additional properties including buy-to-let investments and second homes, the restriction of interest relief for investors to the basic rate of income tax and a change to the current Wear and Tear allowance.
We have reported on these tax changes within our blogs during 2015 but the start of a new year is always a good time to look at the changes that are taking place and how these could impact owners of London investment property.
Perhaps the biggest bombshell of 2015 came when Chancellor George Osborne announced that there will be an additional 3% Stamp Duty tax payable on all additional properties, including buy-to-let residential properties and second homes from April 1st, 2016. Currently, investors pay the same rate of Stamp Duty as an owner occupier. This surcharge will not apply if contracts were exchanged before November 25th, 2015 and completion is after April 1st, 2016. This would typically apply to many properties which have been initially bought ‘off-plan’.
There are many types of investor active in the London property market and it is not a ‘one size fits all’ picture. For example, many investors buy for long-term capital growth, so for them, the increase in stamp duty is not a huge issue, given that property prices in London continue to offer strong long-term growth potential.
So, although the increase in Stamp Duty may seem substantial, many investors will be looking at the long-term growth in value of their portfolio so this tax change doesn’t seem to be impacting their long-term strategy too much. Quite the opposite at the moment as we are starting to see a surge in buying activity amongst investors prior to the April deadline.
From April 2017, the current system of tax relief for interest at higher rates of income tax will be phased out. Currently, landlords can offset the interest they pay on their mortgage repayments against the income they receive from rent payments. They can deduct their costs including mortgage interest payments from their profits before paying tax. Higher-rate tax payers receive relief at 40% or 45%.
This change is being phased in slowly, starting in the tax year ending April 5th, 2018 and will not be fully in place until the year ending April 5th, 2021. For the year ending April 5th, 2018, only 25% of interest will be restricted to the basic rate, from April 5th, 2019 a 50% restriction will apply and from April 5th, 2020 a 75% restriction. Following that, all interest will be restricted to the basic rate.
For many investors, the effect of this tax change will be marginal. For overseas landlords who have been investing in London property for many years, their UK earnings may be at the basic rate of income tax so recent changes will have little effect. Even those paying higher rate tax will still be able to claim 20% of the interest paid. Many professional landlords simply use the rent to pay the mortgage and see the true profit to be the capital appreciation of the property. With continued high demand for housing in London, property values are still predicted to increase over the medium to long-term which is the investment focus of many landlords.
Under the current system, landlords can claim a Wear and Tear allowance each year of 10% of rent – even if no repairs or replacements have been carried out. The higher the rent, the higher the allowance that can be claimed. However, if the landlord has higher capital costs in a particular year, they are still limited to claiming 10% of the rent.
From April 2016, landlords will be able to claim a deduction for the full capital costs of replacing furnishings and appliances in a rental property (but not the initial cost of furnishing it). This relates to all movable furniture, televisions, fridges and freezers, carpets and flooring, curtains, linen and kitchen utensils.
Any fixture to the building that is replaced will be treated as a repair and is also deductible. This includes anything that would not be removed by the owner on the sale of the property such as a bath, toilet, boiler and kitchen units.
The new system may simplify matters for landlords who will no longer need to decide whether a new or replacement item is a fixture, and, therefore, a repair to the property, or not. The replacement of fixtures and furnishings will now simply be deducted from their rental income to calculate their profit. And as the new relief will relate to actual expenditure, it will reflect the real cost of replacing the item, rather than a fixed 10% of rent and this could be a plus for many landlords.
No increase in tax is going to be welcomed by investors but we firmly believe the UK’s tax laws remain transparent and honest. High rental demand together with limited housing supply means that property values are likely to continue their upward trend, making property a solid, long-term investment. As ever, landlords must do their figures carefully to work out whether buy-to-let is still the right option for them.
If you would like more information regarding the tax changes, or any other tax-related issues, please don’t hesitate to contact us. To keep up to date with all the property-related news, subscribe to our Landlords newsletter.
View all posts by Vidhur Mehra