New rules of buy‑to‑let

■ Every day this week EG will be focusing on a different facet of auctions, from what to buy, where to buy it and how to learn from the pros Faced with a 93% increase in her tax bill, landlord and author Samantha Collett thought about selling up her buy-to-let portfolio. But after the disbelief and outrage, came a revelation: buy-to-let is still a good business Accountants say you should never let the tax tail wag the investment dog. In other words, you shouldn’t make investment decisions based solely on tax considerations. It’s good advice. If business makes sense and tax is the reward you pay for being a success, then so be it. But recently, such good advice has come under fire. With the introduction of additional stamp duty, the abolition of the “wear and tear” allowance and the withdrawal of mortgage interest relief, the market for buy-to-let is arguably not quite so enticing as an investment. My story Ninety-three percent. That was my accountant’s prediction of how much my tax bill was going to increase when the full effect of the new tax laws kicked in. As a full-time portfolio landlord with lending, I was one of the hardest hit. Disbelief, outrage, resentment – I felt every emotion going. I had three choices: incorporate as a company; sell up; or “something else”. NLA research shows that 40% of landlords considered switching to a company, but four in five decided it was unsuitable. I can understand that. Incorporating is not easy. Even for somebody like me, who could potentially transfer properties via a partnership agreement and avoid the additional stamp duty and capital gains tax, it didn’t make sense. The key reasons are financial – every property owned personally would have to be refinanced commercially. With that comes huge costs – not only are commercial rates typically 1-1.5% higher (adding between £125 and £188 per month to a £150,000 loan), there are arrangement fees, legal fees, valuation fees, different LTVs – meaning, in some cases, additional equity would be required for new lending. Add to that the redemption fees payable for those in fixed-rate deals, plus the massive hike of those on very low base rate tracker deals and you are talking hundreds of thousands. And all of this is before you factor in the costs of running a company, calculating how income will be extracted, corporation tax due plus the loss of CGT allowance. Transferring property owned personally to a company is an incredibly complicated and costly affair. The second option: sell up. I won’t lie, I did think about this. But not for long. The truth is, I love what I do and believe in the future of the market. So what did I do? I asked myself: Is buy-to-let still good business? My answer: Yes – there is a supply-demand imbalance, population growth, low savings rates, stock market volatility, house price inflation and rents are inflation-linked, but good business requires adherence to “The New Rules of Buy-To-Let.” Know your numbers Tax is a very personal subject, but it is critical to know how the changes will affect you. Take advantage of online taxation calculators such as those provided on the RLA website and speak to your accountant as soon as possible. You can plan the future only when you know your numbers. Reduce borrowing The simplest and hardest thing to do. But with less borrowing, you are less exposed to the new tax laws. Analyse the finance deal and calculate whether capital can be injected to lower the interest rate. With lower loan-to-value ratios you can get better rates – again reducing tax liability. Look to make regular lump-sum overpayments to reduce the capital balance. Focus on killer performance Research the market and check if rents can be raised or if fixtures and fittings can be upgraded to increase rental values. Do the marketing early and prepare to negotiate to reduce voids. Explore the possibilities of converting a single-let to a multilet (house of multiple occupation). Cut loose If a property is not paying its way or performing as you expected, sell. Transferring to a company structure is one alternative, but sometimes the best decision may be to sell and buy a different property. Company purchase Properties bought in a company can still take advantage of the tax reliefs available. However, as David Wright highlights, there are additional factors that come into play. Rental income will usually be taxed at the small companies’ rate (19% for 2017/18), but when income is extracted from a company by an individual – usually as a salary or dividend – this may trigger a tax liability. Also, when a property is sold, any gain is reduced only by the inflation allowance – and extracting gains from the company will have an additional cost. Short-term lets Short-term/holiday lets are treated as a “trade” for tax purposes and full mortgage interest relief can be offset along with full capital allowances (for example, renovation costs) against rental income. In addition, furnished holiday lettings are classified as business assets for CGT purposes, meaning the tax levied is 10%. Sean Thorneycroft, director of Signature Financial Services, has seen one of his investors with a semi-detached house located close to an airport switch to short-term lets and boost his rental from £550 per month to £2,200, utilising sites such as Airbnb and Booking.com. Convert commercial Thorneycroft has seen a rise in the number of investors buying commercial to convert to residential, and it’s a strategy he has successfully employed himself – buying a former pub to convert to a home in multiple occupation. If the property is owned through a company, full relief can still be claimed, and the lower purchase price of commercial buildings, added to the lower rates of stamp duty and potential planning gains make this an attractive proposition. The future looks promising Despite the seismic changes to the taxation of buy-to-let, there are still opportunities to make money: demand is strong, rents are rising and house price inflation is increasing. The new tax rules may have changed a few game plans, but give it time – soon we will all be following the new rules of property investment! WHAT HAS CHANGED ■ From 1 April 2016, the purchase of a residential property over £40,000, if you already own a property, anywhere in the world, attracted an extra 3% stamp duty. ■ From 5 April 2016, the “wear and tear” allowance was abolished, meaning landlords of furnished residential properties were no longer able to claim a deduction of 10% of their net rents. ■ From 5 April 2017, the ability to offset mortgage interest expenses against rental income is gradually being withdrawn, reducing from 75% in the current tax year, to 50%, then 25%, to be replaced by a new tax credit. In future, rental income will be added to any other income to determine the effective tax rate, with income tax being due on this, and a 20% mortgage interest tax credit given. WHAT IT MEANS This example, set out by David Wright, director of Thompson Wright Chartered Accountants, shows how the changes will apply to a landlord paying additional rate tax with gross rental income of £10,000 and mortgage interest of £5,000. 2016-2017 Rents: £10,000 Less mtge interest: -£5,000 Taxable profits: £5,000 Tax:  £5,000 x 45% £2,250 Tax liability: £2,250 2017-2018 Rents: £10,000 Less 75% interest: -£3,750 Taxable profits: £6,250 Tax:  £6,250 x 45% £2,813 Less 25% as tax reducer: -£250 Tax liability: £2,563 2018-2019 Rents: £10,000 Less 50% interest: -£2,500 Taxable profits: £7,500 Tax:  £7,500 x 45% £3,375 Less 50% as tax reducer: -£500 Tax liability: £2,875 2019-2020 Rents: £10,000 Less:  25% interest-£1,250 Taxable profits: £8,750 Tax:  £8,750 x 45% £3,938 Less 75% as tax reducer: -£750 Tax liability: £3,188 2020-2021 Rents: £10,000 Taxable profits: £10,000 Tax:  £10,000 x 45% £4,500 Less tax reducer: -£1,000 Tax liability: £3,500 Increase in tax of £1,250 This means on the profit of £5,000 after interest has been paid, tax of £3,500 is payable. CASE STUDY 1 Refinancing of three-bedroom terrace in Waltham Cross Purchase price 2014: £250,000 Property value 2017: £340,000 Mortgage outstanding: £154,000 (reduced from original £175,000 because of lump sum and regular overpayments) Monthly mortgage payment: £576 at 4.49% (five-year fix) Redemption fees and arrangement fee: £5,179 New remortgage monthly payment: £319 at 2.49% (five-year fix) Monthly rental 2017: £1,450 End result: Property had increased in value following refurbishment works and announcement of Crossrail2. This made it an ideal candidate to refinance to a lower LTV. After all fees, total savings across the new five-year period are £10,241. CASE STUDY 2 Conversion and planning gain of a former pub in Stoke-on-Trent: Purchase price 2016: £178,210 (including fees, SDLT and survey) Conversion costs: £225,590 (including planning, architect fees and furniture) Finance costs: £58,102 Property value 2017: £665,000 Monthly rental: £5,406 End result: Project fully refinanced, no money left in producing £2,200 monthly net profit and retention of unencumbered carpark (on separate title) with outline planning for four houses with GDV of £675,000. This article appears in the summer 2017 edition of EG’s Property Auction Buyers’ Guide. Available in newsagents from 20 May or register here for free digital access. Samantha Collett