How to move on from Buy to Let
The government has sent a stark message to landlords: it stands firmly in the camp of homebuyers and has little interest in property investors or their profits.
The latest blow to the buy-to-let sector came in the March Budget. Chancellor George Osborne announced that he was slashing the capital gains tax (CGT) rate for everyone except second homeowners.
The rate cut came into effect on 6 April: basic-rate taxpayers now pay 10% CGT, instead of 18% previously, while higher-rate taxpayers pay 20% instead of 28%. But, drawing the battle lines in the property market, Mr Osborne announced that landlords and second homeowners are excluded from the tax cut and will still pay the old higher rates on any capital gains they make when they sell a property.
The move is another blow to the buy-to-let sector, already reeling from changes to income tax and stamp duty, on which the Chancellor has refused to budge.
Landlords and second homeowners have had to pay a 3% surcharge on existing stamp duty land tax (SDLT) rates on properties bought from 1 April 2016. This means a first-time buyer purchasing a £250,000 property will pay £2,500 in stamp duty, whereas a landlord will pay £10,000.
Another big change for landlords coming up is the way rental income is taxed. Mr Osborne announced in the summer Budget in July 2015 that the government will slash the amount of tax relief on mortgage payments landlords can claim from the tax rate they currently pay to the basic rate of 20%. The changes will be phased in from April 2017. Landlords who pay basic-rate tax won’t see a change, but those on higher incomes will find themselves losing out.
The Bank of England has also announced proposals to clampdown on buy-to-let mortgages, with landlords facing probing affordability assessments and tougher interest-rate stress tests.
Is it time for landlords to sell up?
Jamie Morrison, partner at chartered accountant HW Fisher & Company, suggests landlords compare their net rental yield – that is, what they are left with each month after costs and tax – under the new rules with the interest they would get if they simply left the money in the bank.
“Savings accounts pay only very modest levels of interest, but they do offer security. If your net rental yield falls to similar levels, it’s time to reassess whether it’s still worth the hassle and risk of being a landlord,” he says.
The managing director of Propertychecklists.co.uk, Kate Faulkner, suggests landlords don’t decide until they have sought advice from an independent financial adviser.
“They need to be very clear on their financial objectives, stop crossing their fingers and hoping property will deliver, or have the attitude that ‘it’s done well in the past, so it’ll be fine in the future’,” she says. “What they need to be very clear on now is how to use the cash they are thinking of investing (or have already invested) in property. It could be more tax efficient to diversify into other things, especially if they own as a cash buyer and are in areas where capital growth is below inflation.”
The income tax changes are being phased in gradually between 6 April 2017 and 5 April 2021. Landlords with large mortgages are likely to see their yields reduce – and possibly even slip into net losses – with the gradual reduction of mortgage interest tax relief. They are also the most exposed to the impact of a rise in interest rates.
Accountants Smith & Williamson worked out that as a rule of thumb, if mortgage interest payments are more than approximately three quarters of the rent after deducting other costs, a landlord paying income tax at 40% will find their tax bill wipes out any profit on the rent.
Therefore, those who have borrowed heavily against the value of their property are likely to suffer the most. In contrast, those who own property outright, without any loans, will not be affected by the income tax changes.
However, selling up might not be a straightforward decision for some, as landlords have to factor in the potential for capital growth as well as rental yields.
The latest data from the Office for National Statistics (ONS) show that house prices are rising more quickly in some areas than others. The average London house price, for example, hit a record of £551,000 in January 2016. This was £15,000 up on December’s figure of £536,000 and translates into an increase of £484 a day.
But while London and the South East have enjoyed double-digit annual growth rates, the property markets in Wales, Scotland and Northern Ireland have slowed considerably.
Transfering to company ownership Donna McCreadie, a buy-to-let tax specialist at Perrys Chartered Accountants, says it is important not to make any rash decisions and suggests consulting with a property expert to assess all options available.
“Changing the ownership of the property may be beneficial, whether between spouses or by the use of a limited company, but there are many considerations to take into account to ensure that your overall net position can be improved,” she explains.
Charlie Owen, associate partner at Russell New, a West Sussex-based firm of business, tax, and charity consultants, points out that the option to transfer personally owned properties to a company has received a lot of publicity.
“Whether it’s a good idea very much depends on the individual circumstances and the forthcoming hike in dividend tax rates should be considered in this context,” he says, “In some cases, incorporation can be very efficient from a tax perspective although the wider commercial aspects should also be considered. Our message is that there is no ‘one size fits all’ solution here and each case needs to be reviewed on its own merits.”
Capital gains tax
Once an investor has sold a property, there could be CGT to pay. CGT is levied on the profit or ‘gain’ on the sale of any property that’s not your principal residence – including buy-to-let property and second homes. The gain is usually the difference between what you paid for the property and the amount you sold it for.
You can make a gain of £11,100 a year before you pay CGT – this is the ‘annual exempt amount’. However, there are a number of ways to further reduce the CGT you pay on property sales. “You can reduce your exposure to CGT by deducting all the costs you incur in the sale from your total gain. These include estate agent’s, lawyer’s and accountant’s fees. You also need to deduct not just what you paid for it, but all associated fees, such as stamp duty and conveyancing costs,” says Mr Morrison.
“There is another valuable way to limit your CGT bill in the form of Private Residence Relief. You can claim this if you lived in the property at some point while you owned it. There’s no minimum time requirement – the test for eligibility is about quality rather than quantity of occupation. You must be able to prove that when you lived at the property it was your primary residence.”
Currently, sellers selling a second property can work out the CGT after the end of the tax year as part of their tax return. So depending on when you sell, you’ll have plenty of time to do the calculations and pay the tax.
But that’s changing. The Autumn Statement in November 2015 included small print that means by 2019, CGT on second homes or rental property will be payable to HMRC 30 days after the property is sold.
What to do with the money from a property sale
Those landlords who do decide to sell up will need to think about the best home for their money.
Patrick Connolly, a chartered financial planner at financial adviser Chase De Vere, says as a starting point you need to decide what you want to achieve, how long you are planning to invest for and how much risk you are prepared to take. Investors must decide whether they need to replace the income generated from buy to let or whether their focus is on capital growth.
“Before investing, you should look at paying off any debts. This could be credit card debt or an outstanding mortgage on your main property,” says Mr Connolly. “You should also make sure you have put aside some money in cash to cater for any short-term emergencies or requirements. This should stop you going into debt or being forced to cash in your investments at the wrong time if you need to get hold of some money quickly.”
A big advantage of not investing in residential property is that you can access tax-efficient wrappers such as pensions and individual savings accounts (Isas). These benefits have increased in recent years, while the tax benefits of buy-to-let property have been diminished.
“Those with a large lump sum to invest after selling a property can use their annual pension and Isa allowances and will also be able to take advantage of the new tax-free Personal Savings Allowance for interest payments and the Dividend Allowance for dividends,” says Mr Connolly.
If you have a lump sum to invest, you can reduce risk by investing into a wide range of different asset classes including shares, fixed interest and commercial property. Diversification should give you the opportunity to make consistent returns and will also mean that all of your investments won’t fall at the same time.
If you would still like to invest in property, consider a property crowdfunding platform such as Property Partner. Investors can buy shares in individual buy-to-let properties in a similar way to how you invest in stocks. Once the property is fully funded, investors receive rental income in proportion to the number of shares they own.
Investors pay a one-off transaction fee of 2% on the purchase of a Property Partner investment, and 10.5% (plus VAT) of rental income, for advertising, letting and managing the property. Property Partner finds the tenants and manages the property, offering a hands- off investment.
Costs of selling up
Landlords who do decide to sell up will find that this comes with costs of its own. Estate agents generally charge between 1% and 3% of the agreed purchase price plus VAT as a fee for their work. Online estate agents are cheaper and normally charge fixed fees of between £400 and £1,000.
Anyone selling a home legally has to provide potential buyers with an energy performance certificate (EPC).This document gives information about the energy efficiency of a property with a rating from A to G. Landlords should already have an EPC – it’s one of the documents they are supposed to provide to tenants. Any landlords who don’t have an EPC can arrange for it to be carried out through an estate agent or by a domestic energy assessor for between £50 and £120.
Vendors also need to instruct a solicitor or licensed conveyancer to deal with the legal aspects of selling a property. Most charge a flat fee of between £500 and £1,500 depending on how complex the transaction is.
In most cases, any buyer will want vacant possession of a property. This means landlords will need to serve tenants notice to leave and factor in a void period between the tenants leaving and the sale completing.
“I will make a loss once landlord tax kicks in”
Landlord Jaye Cook, 38, and his wife Emma, 34 (pictured above with their children, Madison, four, and one-year-old Devon) own five rental properties in Kent but the upcoming tax hikes mean the couple have halted plans to expand their portfolio.
“I’m a Conservative voter and I was surprised at both the changes in the Budget and the Autumn Statement as I think they will alienate Tory voters,” says Mr Cook, “My biggest fear is that I’ll start to make a loss every month once this landlord tax kicks in as we’re going to be taxed on the revenue rather than the profit.These changes will force landlords to raise their rents to make ends meet or they’ll sell up and create a glut of buy-to-let properties on the market.
“My wife and I invested in buy to let instead of a pension and we planned to buy two more properties, but we won’t now. I still believe in property as a long- term investment so when we remortgaged one property late last year we over- borrowed and invested the money in property crowdfunding platform Property Partner instead. This way, we still get a rental yield but without the hassle of managing tenants. We will also benefit from capital growth.”
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
The branch of law concerned with the preparation of documents for the buying and selling of property (or remortgaging), always handled by a qualified solicitor. The conveyancing process covers many of the legal aspects of the sale/purchase/remortgage such as land registry, local authority searches, freehold and leasehold status, title deeds and much more.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.