The new tax year brings a punishing regime for those with buy-to-let property portfolios, which could result in losses if no action is taken, Advies' IFA Alex Reynolds has warned.
Under measures announced by then Chancellor George Osborne in the 2015 Summer Budget, from this April landlord tax relief on mortgage interest payments will gradually be cut from a marginal rate of up to 45% to a flat rate of 20%.
This means property owners will not be able to offset as much of their interest payments against tax, resulting in higher tax charges, and in turn putting many at risk of being pushed into higher tax bands.
From last April buy-to-let investors have also incurred an extra 3% stamp duty on second homes, as part of a pack of measures designed by the government to curb buy-to-let investment and free up the housing market for home buyers.
According to Reynolds, the changes will create big problems for clients with highly geared portfolios and could lead to losses."I've seen a few examples that have shown that although you might be getting a sizeable income, the tax bill is higher than that, so actually the net cash flow is negative," he said.
To illustrate this point Reynolds described a higher rate tax payer (hypothetical) earning £80,000 per year, who owns five properties. Her mortgages total £700,000 and her mortgage payments come up to £21,000 per year, plus £5,000 in extra costs. She has a rental income of £35,000 per year.
The below table assumes mortgage interest rates increased from 3% to 3.75% by 2020/21. It shows that from the beginning of this tax year, her profits gradually decreased over five years until she made a loss of £5,000 in 2020-21
In another example, a client earns £50,000 per year and is also a higher rate tax payer. This time his second home is valued at £200,000, and he has a £150,000 mortgage. He makes £4,500 in mortgage payments each year, with an added £1,000 per year in other costs. His rental income is £7,200 over the year.
Like the previous example, the client gradually made a smaller profit each year, until making a loss in 2019.
Reynolds said: "The likelihood is problems are going to arise, perhaps not this year or next year, but after that, when once a client can't offset those financing costs, the tax bill is going to a rise to a point where it's unaffordable for them to keep all of their properties."
'Buy to regret'
Hargreaves Lansdown chartered financial planner Danny Cox described buy to let as "buy to regret", saying it was one of the "least tax efficient ways to invest". This was because it was subject to stamp duty, income tax, capital gains tax (CGT) and inheritance tax with very few reliefs to offset the tax liabilities, he said.
"Capital gains tax is not the property investor's friend," he said. "Rising asset values and, unlike share portfolios, no realistic opportunity to spread gains over multiple tax years make realising chargeable gains a binary, all or nothing decision."
For Cox, the 2016 Budget made the situation worse, as the rate of capital gains tax was reduced for most investments, but not for second or investment properties.
This meant a higher rate tax payer would pay 20% CGT on shares and funds, but 28% on buy to let, he said.
EIS as an alternative
Kin Capital co-founder Richard Hoskins suggested a solution to large CGT liabilities could be to invest in Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS), albeit at a higher risk.
The average price of a house in July 2016 was £232,885, said Hoskins. This meant even the average house was likely to generate a CGT liability in excess of £11,100 per year, he said.
"An additional rate tax payer, with a CGT liability crystallised from selling a buy-to-let property can get 64% tax relief per £1 invested in SEIS. If that additional rate tax payer loses 100% of their investment, they will receive a further 22.5% of tax relief on the loss and that is on top of the 64% tax relief received already. Effectively this means the investor is risking 13.5p per £1 invested in an SEIS company," he said, adding: "It's difficult to argue the maths of SEIS investment aren't compelling."
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