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Incredible as it may seem today, there was a time when individuals buying property to rent out – to students and others – were considered a rather eccentric bunch, their modus operandi perceived as a strange, almost grubby way of making money.

Perhaps this had much to do with the old fashioned image many people held of the rent man, an officious, almost Pythonesque character, replete with well-worn leather satchel and compulsory brown ‘mac’.

This image underwent a radical revision once Business Expansion Schemes (BES) were introduced in the 1990s when letting residential property started to make commercial sense. Yields were high enough for rental income to cover mortgage costs and, as property values soared, more people took advantage of generous tax breaks, particularly those permitted in BES structures, using them as a means of acquiring property portfolios.

Nowadays, of course, buy-to-let (BTL) is a recognised investment asset class. In addition to quoted companies such as Grainger plc, which owns and manages more than 26,000 rented properties in the UK, there are an estimated two million private landlords who between them own almost one in five homes in Britain; according to research conducted by mortgage lender Paragon, they will buy a further one million properties over the next five years.

At present, some 18% of households rent their homes from private landlords. Last autumn, the government published statistics which suggested that by 2032, more than one in three properties will be owned by private landlords. In the space of a quarter century, buying to let has gone from being perceived as an eccentric pursuit to a perfectly respectable investment activity. But for how long?

The fallout from George Osborne’s shock announcement in July, when he proposed the introduction of a series of changes to the way in which BTL investors benefit from receiving tax relief on mortgage interest and other finance costs, continues to spook a sector that has enjoyed a phenomenally lengthy bull run.

From April 2017, the new measures will restrict relief for finance costs on residential properties to the basic rate of income tax; such costs include mortgage interest, interest on loans to buy furnishings or fittings and fees incurred when taking out or repaying mortgages or loans. No relief is available for capital repayments on a mortgage or loan.

BTL investors will no longer be permitted to deduct all of the finance costs from their property income to arrive at a net profit figure upon which a tax liability may arise. They will instead receive a basic rate reduction from income tax liability to cover their finance costs. In other words, where applicable, the tax liability will arise on turnover, ie rental income, not on net profits.

From the 2017-18 tax year, deductions will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction; by 2020-21, this concession will have been phased out and all financing costs incurred by landlords will be permitted only as a basic rate tax reduction.

The impact of these changes will fall heaviest on higher-rate tax payers who have large mortgages.

Officially, the government maintains the changes are designed to “make the tax system fairer, [by restricting] the amount of income tax relief landlords can get on residential property finance costs…[to] ensure that landlords with higher incomes no longer receive the most generous tax treatment”. However, a document issued by the Office for Budget Responsibility reveals that between 2018 and 2021, the net benefit to the Treasury will amount to more than £1.3 billion and be worth upwards of £700 million a year thereafter.

As expected, there has been plenty of knee-jerk reaction to the proposed changes with some commentators suggesting that faced with a significantly greater tax liability, private landlords will sell up en masse, tenants will see a surge in rents and the supply of properties available to rent will plummet. This seems extremely unlikely as BTL investors will instead seek alternative methods of legitimately avoiding the tax hike.

In many cases, for instance, properties could be transferred to a spouse who may enjoy a lower rate of tax, though the most attractive potential alternative for a number of individuals will be to operate through a limited company. In such instances, all property finance interest is allowable against tax and, if the company is established in the UK, there is the added benefit of corporation tax falling to 18% from 2020.

There are, however, costs associated with transferring a property into a limited company: if a property is valued at more than £125,000, a stamp duty liability will arise and, when the property is sold, the limited company could incur a capital gains tax charge. Moreover, some lenders balk at the idea of lending to companies for BTL investments and those that do tend to charge higher rates of interest as loans are considered commercial debts.

Nevertheless, Mr Osborne’s proposals (for that is what they are at the moment) are detailed in a document headed ‘Restricting finance cost relief for individual landlords’, the title of which suggests that corporately-owned BTL investments will remain unaffected – at least for the foreseeable future. Some existing BTL investors may, therefore, consider ‘biting the bullet’ now and establish a limited company within which they can administer their investments in a more tax-efficient manner.

For more information, contact:
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