How to avoid the new buy-to-let tax

This reader is one of many landlords who face higher tax bills under rules introduced this week. Laura Suter outlines her options

This week marked the introduction of profound changes to the taxation of buy-to-let investments, leaving landlords scrambling to protect themselves from higher tax bills. On Thursday buy-to-let investors became unable to offset all their mortgage interest against their profits. Within three years none of the interest will be tax-deductible. The changes mean that many landlords will pay more tax – and in some cases will be taxed on nonexistent profits.

What has changed?

Higher-rate taxpayers can no longer offset all their mortgage interest against rental income before calculating the tax due. This will lead to higher tax bills even if investors have not seen their income increase.

The reduction in relief is being phased in between now and 2020 and will be replaced by a 20pc tax credit. From this week landlords can offset only 75pc of their mortgage interest against their profits. This falls to 50pc next year, 25pc in 2019 and zero in 2020.

While the move mainly affects those who already pay higher-rate income tax, it will push some basic-rate taxpayers into the higher-rate bracket once their rental income has been taken into account. Others will lose means-tested benefits.

The change applies only to private individual landlords and not to those who own property through companies. Claire Williams is one of many buy-to-let investors to be hit by the new rules

What can be done?

Landlords will need to become more focused on their costs, said Alistair Hargreaves of John Charcol, the mortgage broker. “Landlords need to plan and be prepared. If they are already a landlord and are putting off understanding the impact of the tax on them, they need to see their tax adviser and ask what the damage is,” he said.

Mr Hargreaves said he had clients who were selling their London buy-to- let properties – which would otherwise “ruin them in tax” – and buying two or three properties elsewhere, doing so via a company in order to dodge the tax changes. This is despite them facing potentially huge capital gains tax bills.

“If you’re a top-rate taxpayer it’s probably the right thing to do,” Mr Hargreaves added. “A lot of the things you can do to protect yourself are very costly, so a plan is needed.”

Those who own smaller portfolios or who will not be so badly crippled by the new taxes need to focus on costs, said Mr Hargreaves. This can include getting a lower mortgage rate or reducing the mortgage amount. Raising rents is another option.

‘I’ll pay £650 a year more in tax’

Claire Williams is one of the thousands of investors to be caught out by the new rules. Now 26, she bought a buy-to-let property in Hayes, west London, in 2014. She also bought her own home in Swanage, Dorset, at the end of last year.

Ms Williams is an “accidental landlord”: she put in an offer to buy the Hayes property before the estate agent told her it had sitting tenants who would remain in the property. After increasing her deposit by taking a small loan from her parents, Ms Williams bought the two-bedroom house for £242,000, which she called an “absolute bargain”.

Her £168,000 interest-only mortgage costs £290 a month. Her tenants pay £950 a month, but Ms Williams is banking on the property value rising as the house is well located for the Crossrail development, which will cut travel times to London.

She earns £38,000 a year as an IT trainer, making her a basic-rate taxpayer. However, her rental income pushes her into the higher-rate tax bracket, meaning that she will be hit by the new tax.

Where previously Ms Williams would have been able to deduct the £3,240 a year she pays in mortgage interest from her profits, she will soon pay tax on the whole £11,400 a year she makes in rent.

Because the new tax is being phased in she will not see the full impact immediately, but when the changes are fully in place by 2020 she faces an additional £650 tax bill each year (see table on Page 3).

Ms Williams admitted that while she was aware of the tax changes, she had not prepared for them. “I understand the maths, and I’m mentally preparing myself for a

higher tax bill, but I haven’t started to prepare financially,” she said.

Experts said Ms Williams has some options: raise the rent, accept the hit to her finances, or sell (see box for more detail).

If she does raise rents she is unlikely to be alone. A recent survey from the Residential Landlords Association found that two thirds of members expected to increase rents to deal with the new tax. The association said landlords were likely to raise rents by between 20pc and 30pc.

Already landlords have been taking a number of routes to help protect their finances from the move. Some have remortgaged their main residence to pay off some of the mortgage on their buy-to-let properties, as home owners typically get lower rates on residential mortgages than buy-to-let mortgages. Others have moved their properties inside a company, although this comes with additional costs.

Mr Hargreaves said one option for Ms Williams would be to use a

Claire Williams will have to raise the rent on her buy-to-let or face the tax rise

buy-to-let offset mortgage (see Page 2) to help cut her costs. She could put any savings or rental income into the offset account, reducing her monthly interest bill.

However, she would not meet the criteria for the buy-to-let offset mortgage from the Family Building Society, which “stress tests” all its applicants to ensure they can afford the loan. The test is based on how much rent landlords are taking compared with how much they could pay on their mortgage if interest rates rose.

For the Family mortgage, Mr Hargreaves said Ms Williams would need £1,100 in rental income each month, £150 more than she currently makes, as its test requires up to 145pc of the mortgage cost to be covered by rent at an interest rate of 5.5pc.

The buy-to-let offset mortgage from Hinckley & Rugby Building Society would require only £450 a month as it requires up to 135pc of mortgage costs to be covered by rent at an interest rate of 2.89pc.