When looking to invest in a second property to potentially let and maximise capital growth, it is now far more expensive to buy than it used to be as stamp duty has increased. The 3% stamp duty surcharge was introduced in 2016 which means owners pay an extra 3% on the standard stamp duty rate for second homes.

The average house price in London is in excess of £500,000 and the stamp duty homeowners pay if it’s their residential property is roughly £15,000. However, if it’s a second property this jumps to £30,000 (3% of £500,000).

Buy-to-let Landlords Under Pressure

As well as becoming more expensive to buy a home it is now costlier to own and maintain a property too. The 10% wear and tear allowance, a tax-deductible cost based on the gross rent received, has been replaced. Landlords’ tax bills are also rising as tax relief on mortgage interest is being phased out. From April 2020, landlords will no longer be able to deduct their mortgage costs from their rental income.

This could signal the end of buy-to-let investments for all but the super-rich and buy-to-let borrowing figures support this forecast. The number of buy-to-let borrowers fell significantly from 29,100 in March 2016 to 4,200 in April 2016 – the month when the stamp duty surcharge was introduced.

The increased cost of buy-to-let mortgages (as reported by Assist Inventories in November 2017) combined with the loss of tax relief on mortgage interest payments then the attractiveness of owning additional properties is declining. Mortgage interest tax relief reduction will particularly impact those in the higher or additional rate of tax who are often looking to invest their cash.

Mortgage Interest Tax Explained

A higher-rate tax payer, for example, who rents a property out for £15,000 but has mortgage interest payments of £14,000 will only pay tax on the £1,000 profit at 40%. By 2020 the £15,000 can only have £7,000 of mortgage interest applied as a tax-deductible cost (take £14,000 and multiply by 20/40) which creates a tax bill of £3,200. This is a rise of 800% in the tax bill and would create a cash loss for the property owner of £2,200 (£15,000 – £17,200).

If the mortgage interest is 75% or more of the rental income then the profit is wiped out completely. The mortgage interest tax deduction will also push many basic rate tax payers as the tax bracket will now be based on gross rental income.

An example would be a landlord who has a £35,000 salary and lets a property for £15,000 but pays £10,000 in mortgage interest. They would previously have been taxed at the basic rate as their income would be £35,000 plus £5,000 but under new rules their income is £50,000 which pushes them into the higher-rate tax band where the mortgage interest deduction rules apply.

Working Around the Tax Relief Loss

One avoidance method is to have a UK limited company to own the properties. Because these properties are viewed as a business, all expenses can be written off for tax purposes.

However, the landlord will have to pay Capital Gains Tax on any gains on current properties they own if they did sell them to their limited company. This may end up costing more overall and should be researched thoroughly before completing. From April 2019, landlords will also have to pay their CGT on profits within 30 days of selling the property, so the even the cash flow advantage of selling a property is disappearing.

Many landlords have reacted to the negative news by putting new property purchases through a limited company. There is a higher administrative burden as landlords need to complete annual accounts and submit these to Companies House and HMRC but the cost of servicing these requirements is far lower than the added tax burden of keeping these properties personally owned.

Whatever investors decide to do, it’s worth speaking to an accountant or specialist tax adviser who will assess your personal situation and advise on the best approach for you. The London team of Cottons Chartered Accountants provide fresh accounting services, specialising in cloud accounting and making tax digital. The branch has a deep knowledge base to assist clients not only with their tax and accounting but with business planning, financial forecasting and research and development too. Contact them today to find out about their high quality accounting services and packages.

This article was contributed by Cottons Chartered Accountants in London.