Buy-to-lets in a high-interest era
Let’s look at the tax implications for landlords of buy-to-let properties after interest rates have risen significantly in a little over a year. The Bank of England base rate was a mere 0.1% in September 2021 and stayed there until the end of that year.
At the time of writing (November 2023) it is now 5.25%. Some of us are old enough to remember when mortgage rates reached more than 15% p.a. but I don’t think we have ever seen base rates rise by more than 5,000% in such a relatively short period of time.
What are the implications for a tax regime last reformed at a time when interest rates were immodestly modest, but borrowing was nevertheless still quite accessible?
Recap As with so many tax travesties, we need briefly to cast our minds back to summer 2015, when Chancellor George Osborne, the hitherto largely unsung ‘Angel of Austerity’, announced a cunning plan supposedly to rein in buy-to-let (BTL) mortgage borrowing. It is arguable that the Prudential Regulation Authority’s revised criteria for lending to ‘portfolio landlords’ since 2016 have been more effective, but we are where we are. The current regime disallows interest relief for income tax purposes – which might easily push the residential property landlord into a higher rate of tax – but then gives a 20% non-repayable tax credit (reduction) against their eventual liability. So long as they remain a basic-rate taxpayer, the ‘credit’ will suffice – usually.
Otherwise, there is an effective tax penalty (ITTOIA 2005 s 272A et seq.). Of course, given that this regime applies only to income tax, corporate landlords (residential or otherwise) are unaffected. Commercial lending rates have almost doubled to around 7% p.a. from around 4% p.a. in September 2022.
The tax implications for a BTL landlady – example
Effect of interest rate increase Cassandra is a surgeon with a single residential rental property. She already pays 40% income tax on her salary. She clears £2,000 per month net rental income after agency and maintenance costs, with a £150,000 interest-only mortgage.
Having fixed her finance costs around three years ago at 4% interest-only, she is now about to fix again for the next five years from March 2024, at a relatively eye-watering 8%: 2023/24 2024/25 £ £ Net rental income – real profit 18,000 12,000 Add back: BTL mortgage interest (4%/8%) 6,000 12,000 Taxable rental profit 24,000 24,000 Taxed at 40% 9,600 9,600 Less: basic rate tax reduction 20% (1,200) (2,400) Net tax on rental income 8,400 7,200 Effective yield net of income tax 9,600 4,800 What it would have been, before BTL tax adjustment 10,800 7,200 Cassandra is being punished twice over:
• Her finance costs have doubled, so her real profit has fallen.
• The built-in tax penalty for the mortal sin of a BTL mortgage has also doubled.
Given that Cassandra’s residential letting finance costs are effectively ignored for tax purposes, the substantial real-world increase in mortgage interest rates has had no effect on her assessable income, against which the thresholds for student loans and child benefit clawback are measured (amongst others). All other things being equal, Cassandra’s net-oftax income from 2024/25 will be half what it was up to 2023/24 (and it was already 1/9th lower since 2016, thanks to the BTL tax adjustment before interest rates increased).
But ‘all other things’ will likely not remain equal, as the strength of demand in the rental market means Cassandra will probably be able to increase her rent charge. Hidden costs exacerbated There are other traps lurking in the BTL tax regime, which can apply where the taxpayer’s investment income is significant. This is because the 20% tax ‘credit’ is available only when it may be applied to reduce tax on income that is not from interest or dividends.
The most likely victim will be someone who is retired or is otherwise largely reliant on investment income. One might wonder if those who supported the idea of the 2015 punitive tax grab against ‘greedy landlords’ are now complaining that there are no longer so many rental properties on the market – or, for those properties that remain, the rents are becoming significantly more expensive.