This post is a public answer to question I’ve been getting a lot since George Osbourne did his best to screw landlords…
Although I’m not bitter. Seriously. I get it; public finances were in an enormous mess and increasing tax on landlords is hell of a lot more politically acceptable than say, raiding pensions or cutting welfare. Oh, wait…
But seriously, we can complain or we can apply ourselves and adapt.
In this post I’m going to give you a quick overview of the recent changes to the market, and my views on them (I’m not going into depth here, I’ll expand further in individual posts).
So, unless you’ve hiding under a rock for the past few months, you might have noticed there have been some major tax changes which affect property investing.
Nothing makes a better headline than the apparent ‘death’ of buy to let, and it’s easy to get swept up in the hype.
But we need to keep a cool head. So here are the facts:
- Stamp duty is up an additional 3%: tough, but not a game changer
- Mortgage interest is no longer a deductible expense: this has the potential to cause some real problems. But if you buy the right property in the right way you’ll retain more profit and be able reinvest more (faster)
There is now an additional 3% stamp duty on a purchase of a second (or third etc) home, i.e. any residential investment property assuming you own your own home.
That’s a noticeable chunk of cash, but it’s hardly game changing.
On a property worth £200,000 that’s an extra £6,000.
Would it be nicer if that wasn’t there? Of course. But if you’re thinking long term – and I assume if you’re on this site you are- it’s a tiny little dent in your returns even over 5 years let alone 10 or 20.
In short, this is just something to work into your overall sums when assessing a potential investment.
But the biggy isn’t the stamp duty, it’s the removal of mortgage interest relief…
Mortgage interest relief
Up until 2017 the interest you paid on a mortgage was a deductible expense when calculating your tax. So you earn rental income, pay your running costs and mortgage interest, and pay tax on whatever net profit remains. Straightforward, reasonable.
Between 2017 to 2021 however the ability to offset your mortgage interest as an expense is being phased out. You’ll still have this expense (assuming you have a mortgage), but you won’t be able to deduct it as an expense when calculating your tax bill.
What you’ll realise is this gives HMRC an unrealistically high ‘net’ profit to tax- they’re ignoring a significant expense. You will be able to deduct 20% of the value of your mortgage interest from your tax bill, but that still leaves 80% as an expense to pay which is not deducted.
You are being taxed on a profit that does not exist.
Not straightforward, and certainly unreasonable. But is there any point complaining about it? No.
You simply need to think a little differently.
The solution is simple. The mortgage interest relief restriction only applies to mortgages held by individuals. Properties held by limited companies are exempt.
Set up a ltd company (a ‘Special Purpose Vehicle’, or SPV) and purchase the property within the company, and the restriction does not apply.
Take a look at the graphic below to give you an idea of the difference holding a property individually vs via a company will make.
The red (total tax paid) and the green (profit after tax) are the ones to keep an eye on. Less red and more green is what we want. This is based on 2 HMOs which together earn £60,000 in rental income; your gross profit. They have £10,000 total running costs and £12,600 in mortgage interest (rising to £15,000 for those in company ownership due to slightly higher interest rates).
The main takeaway: if you want to retain the profits to reinvest, the increase in profit with corporate ownership is substantial.
There is also talk of corporation tax reducing to 17% over the coming years, which would reduce tax and boost profits further.
Now, if you’re going to extract all the profits from the company the benefit of corporate ownership is only small, and factoring in some higher accountancy fees could be broadly equal…at the moment.
But here’s the critical point: whilst the difference in today’s current low interest environment is not huge, the ability to offset the mortgage interest as an expense is a hedge against interest rate rises.
If you can offset mortgage interest against gross profit and interest rates rise (which they will at some point), your tax bill reduces as your expenses increase, meaning profit is protected for longer.
If however you cannot offset that expense, when interest rates rise your outgoings rise but your tax bill stays the same. Your profit is not protected. You could quickly be pushed into making unsustainable losses.
Are costs to company ownership a barrier?
The costs of owning a property in a company used to be a barrier: mortgages for limited companies were expensive and rare, but not so any more.
Specialist lenders are widening the choice of mortgage products available to companies. Challenger banks are seeing this as an opportunity for them to do what they’re good at: disrupting the market with new products and lower rates to try and steal business away from the big boys.
I think we’re going to see more of this.
The mortgage market is responding, which is good for the investor.
Accountancy costs will be a little higher, but again nothing that will break the bank.
So in summary, the environment has changed. But things always change. Adapt. Keep yourself up to date and in the know.
By taking the right approach to your investment you’ll not only pay less tax, you’ll be able to reinvest more, faster (if you choose).
You can thrive!
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In upcoming posts I’ll cover yet more recent changes, this time to financing, and outline why they should absolutely not be a concern (but for many probably will be).
And remember people: the information here is views and opinions, not tax advice. Always do your due diligence. Consult tax and legal professionals. Don’t be stupid.
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