Understanding LISA interest rates: a comprehensive guide
Understanding LISA interest rates is crucial for individuals looking to make informed d...
Residential property under attack?
The sky-high price of property and rise of Generation Rent have put buy-to-let properties firmly in the spotlight. Property to let is the only type of investment where it’s possible to borrow money to invest and claim full tax relief on the interest payments. The Chancellor now feels this tax break is overdue for reform and between 2017 and 2020 higher rate tax relief will effectively be withdrawn.
Basic rate taxpayers may also be affected as the new rules will mean that tax is due on income before the deduction of interest payments, rather than on net income, pushing many into the higher rate band. A 20% tax credit on mortgage interest will then be available.
The table below shows an example of how the rules will affect private landlords. Those with larger mortgages and lower-yielding properties will suffer most… and some may even start to make a loss. It is clear from the direction of legislation that it’s the government’s intention to professionalise the industry, leaving the way clear for larger property companies rather than buy-to-let landlords with one or two properties.
| Income | Mortgage Interest | Taxable Income | Income Tax @ 40% | Tax Credit @ 20% | Tax Paid | Profit | |
|---|---|---|---|---|---|---|---|
| 2015 | £20,000 | £15,000 | £5,000 | £2,000 | N/A | £2,000 | £3,000 |
| 2020 | £20,000 | £15,000 | £20,000 | £8,000 | £3,000 | £5,000 | £0 |
Consequently, some landlords are now considering the merits of managing their property through a company, which isn’t without its issues either. There are two layers of capital gains tax. First in the company, and then on the disposal of any shares. And as companies are immortal, the capital gains exemption on the death of an individual who owns an asset directly will not apply. Taking out any profits via dividends will also become more costly after April 2016 when all taxpayers drawing more than £5,000 will be subject to an additional 7.5% tax. This approach to investment property taxation will not apply to furnished holiday accommodation or to properties managed through a company.
Using a company
The second attack on the buy-to-let market is the abolition of the wear and tear allowance. Landlords can currently deduct 10% of the net rent, whether or not they actually spend this money. But from now on, only actual expenditure will be tax deductible.
From April 2015 foreign investors will be required pay capital gains tax on any UK property, which, together with the new 12% stamp duty band, may make some look elsewhere for their next investment.
The future is turbulent
As a result of these cooling measures, property as an investment is facing some considerable turbulence, however many people still believe that a shortage of supply will continue to drive prices higher in the belief that ‘house prices never fall’. This isn’t true of course. Between 1988 and 1993, London house prices fell by almost 30%. Prices recovered over time, but it took nearly a decade, and much longer in real terms.
Valuations look pretty inflated. This doesn’t mean that prices won’t rise even further, but the ratio of London house prices to average incomes is now the highest on record. Despite this, mortgage payments, expressed as a percentage of income, are only just above their long-term average, so affordability remains reasonable. That picture would change considerably if interest rates rose again to ‘normal’ levels.
Higher interest rates and taxes may therefore create a perfect storm for property investors in the coming years. All of this might be painful for us, but our children will be delighted!
Ian Thomas is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.
