Conditions have been favourable, with lending more accessible, interest rates low and investors and lenders alike not as apprehensive of taking a risk. Typically, a 25 per cent deposit is required and possibly a hefty arrangement fee, although the best mortgage deals demand a minimum deposit of 40 per cent. Normally, lenders will set the expected rental yield at 125 per cent of the mortgage repayments and even though the interest rate for buy-to-let is higher than for standard mortgages, rates are low, making it easier to meet this criteria.
But has investing in property lost its appeal? There have been changes to certain tax reliefs available to landlords of buy-to-let properties, including the phased restriction of relief on mortgage interest and a replacement allowance introduced in place of the 10 per cent wear and tear allowance on fully furnished residential properties. In addition, both the UK and Scottish Governments announced a 3 per cent surcharge – Additional Dwellings Supplement (ADS) in Scotland – on the purchase of second homes costing more than £40,000 (see John McArthur’s article, left).
In Scotland, Land & Building Transaction Tax (LBTT) replaced Stamp Duty Land Tax and is a progressive system for transactions. It is structured in such a way that the tax charge is more proportionate to the purchase price and is not, as in the past, levied on the full purchase price.
For example, there is no LBTT charge on a property costing less than £145,000 and between that figure and £250,000 it is 2 per cent. So for a property purchased at £185,000, the LBTT would be £800. This £800 is also an allowable deduction when calculating the capital gain arising on the eventual sale. Based on current rates, basic rate taxpayers would pay 18 per cent on any gain arising, and higher and additional rate taxpayers, 28 per cent. Effectively, the LBTT tax charge would attract tax relief at between £144 and £224 on the original outgoing of £800.
Investors must also take into account the ADS of 3 per cent, so for the same property purchase of £185,000 the charge would be £5,550. Again, this charge would be available as a deduction against the eventual capital gain, with the tax relief being between £999 and £1,554, depending at what rate CGT is payable by the individual.
There is also income tax to factor in on the net rental profit. In arriving at the net profit, a landlord may deduct certain allowable expenses, which have been incurred in the letting process. These include letting agents’ management fees, certain repairs and maintenance, insurance and advertising. Prior to 6 April 2016, landlords of fully furnished residential properties could deduct a wear and tear allowance of 10 per cent of the net rent. This has been replaced with a relief that allows landlords to deduct the actual cost incurred for replacing items such as furniture, furnishings and appliances.
It will be interesting to hear landlords’ views over the next tax year comparing this replacement relief with the old allowance. There will undoubtedly be winners and losers!
From 6 April 2017, a further change will be introduced which restricts mortgage interest relief to the basic rate of tax, currently 20 per cent. Not only is this an unwelcome change for higher and additional rate taxpayers, it seems rather unfair as the cost of finance is a clear expense in any other business situation and treated as an allowable deduction against profits.
Prior to April 2017, income tax is payable on your net rental income after deducting allowable expenses, which includes mortgage interest, with the result that landlords paying higher (40 per cent) or additional (45 per cent) rate tax could claim tax relief at their highest rate. The changes are being phased in over four years so by 6 April 2020, tax relief can only be reclaimed at the basic rate. The phased implementation may lessen the impact for higher and additional rate taxpayers.
Owning a second home as a buy-to-let or a holiday home for many is an aspiration and whilst the Government(s) have targeted these types of investments, has this taken the shine off the dream? Certainly, by being aware of the tax implications and with careful planning, buy-to-let could still be the right thing for you.
Laura Brown is Head of Tax, Murray Beith Murray