Richard Dyson in The Telegraph
Hundreds of thousands of landlords and their accountants are digesting the impact of George Osborne’s shock tax change unveiled in the summer Budget on July 8.
The tax increase, on which there was no consultation, will be phased in from 2017 and fully implemented by 2020.
The change was unexpected, and the new regime is highly complex, so investors and their tax advisers are only now fully grasping its effects. Many investors remain unaware of the change, or underestimate its severity.
All higher-rate taxpayers who own buy‑to‑let properties on which there is a large mortgage will pay substantially more tax. Some current basic-rate taxpayers will also be hit, because the change will push them into the higher-rate tax bracket.
Those who are worst affected will see:
● the actual tax they pay on their investment rising twofold or more;
● the tax rate payable rising above 100pc, meaning that more than all of their profit is paid in tax;
● a degree of tax that pushes them into loss, making their investment financially unviable and forcing them to increase rents sharply – or sell.
Scroll down for a worked explanation of the changes.
What is also becoming clear is that worst hit will be those modest, middle-class savers who have prudently chosen to invest in buy‑to‑let, often alongside pensions and Isas, as a means to supplement their income.
The mechanism of Mr Osborne’s tax attack is the removal of landlords’ ability to deduct the cost of their mortgage interest from their rental income when they calculate a profit on which to pay tax.
So very wealthy landlords who do not need mortgages are untouched.
• Comment: This Alice in Wonderland tax sets a new benchmark in financial absurdity
In effect, the Chancellor wants to tax landlords on their turnover rather than their profit, meaning that tax will be payable on nonexistent income. This explains why tax rates will, for some, exceed 100pc: landlords will have to pay all of their profit in tax, and then pay more tax still.
As landlords absorb news of this shock tax attack, many have turned to online forums to vent their dismay. Some are writing to their MPs and directly to Mr Osborne.
More than 14,000 have signed an online petition calling for the tax to be withdrawn.
Other buy-to-let investors, though, remain unaware of the tax bombshell poised to wreak havoc on their finances. Accountants, mortgage lenders, brokers and other professionals are themselves still working through the ramifications.
Tina Riches, tax partner at accountancy and investment firm Smith & Williamson, said: “We are contacting all of our clients who have mortgaged property which they let, and we want to speak one-to-one with those worst affected. It is going to have a significant impact.”
Smith & Williamson has calculated that any higher-rate taxpayer landlord whose mortgage interest is 75pc or more of their rental income, net of other expenses, will see all of their returns wiped out by 2020.
So mortgage costs above 75pc of rental income will mean the buy‑to‑let investments become loss-making.
For additional-rate (45pc) taxpayers, the threshold at which their investment returns are wiped out by the tax is when mortgage costs reach 68pc of rental income.
The investors worst affected are therefore likely to be those who have bought recently with large mortgages. Low-yielding properties, such as those in London and other parts of the South East, where rents are comparatively low relative to property prices, will also be exposed. That is because rental income is likely to be lower relative to investors’ mortgage costs.
“It will be very difficult for middle-income borrowers to get into buy‑to‑let in future,” Ms Riches said. “It won’t end overnight, but existing investors will sell and far fewer will buy. Buy‑to‑let may well waste away.
“The wider worry is that the Government can make such radical changes without any consultation. What other areas will come under attack?”
Connie Cheuk owns 5 Properties - Photographed at her home in Littlehampton. Photo: Philip Hollis
Read how Connie Cheuk (pictured above), a landlord with five properties, will see her tax bill rise by almost 40pc. She is even contemplating giving up her 18-year career as a teacher as a means of reducing the tax impact
Britain’s big mortgage banks are reluctant to comment and appear to want to downplay the impact, perhaps to reassure their shareholders. But a senior executive at a top-five buy‑to‑let lender admitted privately to Telegraph Money: “For a group of customers there is a challenge, a potential for their cashflow to turn negative. They will be loss-making. Overall, this move makes it substantially harder for investors to generate a net income from buy‑to‑let.”
Of the many landlords to contact us, several are considering selling. This would enable them to pay off mortgages and limit the tax damage. Others will evict tenants and refurbish properties so they can be re-let for more.
One landlord described how a property currently let to a single mother of four, who is on benefits, will “not wash its face” once the tax starts to bite. If he converted the property into two units he could increase the current rent to cover the tax. The council would have to rehouse the family, he said, “and there is already an acute shortage of housing in that area”.
Another landlord described a £110,000 property, on which there is a £68,000 mortgage, let to an elderly couple at “about two thirds of the going market rent”. It generates an annual £1,100 profit, which would fall to £370 after the tax change.
“The property needs a new boiler, which would wipe out profits for years,” the landlord said. “My options are to increase rent significantly, which the tenants can’t afford, or evict them and sell up, or convert the property into smaller units.
“The Chancellor doesn’t grasp the misery he’ll cause – or doesn’t care.”
When George Osborne announced the change, he implied that the extra tax would hit only higher-earning landlords.
It’s true that every mortgaged landlord who pays 40pc or 45pc tax will indeed pay much more under his proposals.
But some basic-rate taxpayers will also pay more tax – because the change will push them into the higher-rate bracket.
In fact, contrary to Mr Osborne’s suggestion, the only buy-to-let investors who will not be hit are the very wealthy who buy property in cash and who don’t need a mortgage.
At the heart of the change is landlords’ future inability to deduct the cost of their mortgage interest from their rental income.
In other words, tax will be applied to the rent received – rather than what is left of the rent after the mortgage interest has been paid.
Here is a worked example assuming you, the landlord, pay 40pc tax.
Your buy-to-let earns £20,000 a year and the interest-only mortgage costs £13,000 a year. Tax is due on the difference or profit. So you pay tax on £7,000, meaning £2,800 for HMRC and £4,200 for you.
Tax is now due on your full rental income of £20,000, less a tax credit equivalent to basic-rate tax on the interest. So you pay 40pc tax on £20,000 (ie £8,000), less the 20pc credit (20pc of £13,000 = £2,600), meaning £5,400 for HMRC and £1,600 for you. Your tax bill has therefore gone up by 93pc.
Now, say Bank Rate – and in turn your mortgage rate – rises by a small fraction, lifting your mortgage cost to £15,000, while your rent remains at £20,000.
You will have to pay £5,000 tax in this scenario, so you make no profit at all.