Buy-to-let tax changes: the ultimate guide

In 2015, George Osborne shook up the buy-to-let market with new tax measures announced in the Summer Budget and Autumn Statement. In this guide we cover what all the changes mean to you as a buy-to-let investor.

The four key changes are:

The government estimates that the measures will affect 1 in 5 landlords, and in some cases tax could even exceed 100% of profit. Read on to find out when and how the changes will affect you, and what you can do to prepare.

Stamp Duty changes from April 2016

Affects you if:

  • You're planning to purchase a buy-to-let property or second home
  • You already own a home which you use as your main residence
  • The property you're buying is England, Wales or Northern Ireland
  • The transaction will (or might) complete after 31 March 2016

What's changing?

Essentially, Stamp Duty will be 3% higher for most buy-to-let purchases than for people buying a main residence. The rules apply to anyone buying additional residential properties in England, Wales and Northern Ireland, including second homes.

If you or your partner already own one property such as your own home, these are the new Stamp Duty rates that will apply to buy-to-let:

Table showing UK Stamp Duty Land Tax rates from 1 April 2016. The higher rate is payable on buy-to-let and second homes.

Source: HMRC

A few notes to explain how Stamp Duty is calculated from this table:

  • There will be no Stamp Duty to pay on properties sold for up to £40,000 – you don't have to complete a Stamp Duty return for these transactions
  • For transactions between £40,000 and £125,000, Stamp Duty is calculated on the whole of the purchase price
  • Above this level, the tax is calculated on the portion of the property price that falls into each band.

When does the Stamp Duty change take effect?

The changes are due to take effect on 1 April 2016, so you'll need to complete your purchase by the end of the day on 31 March.

How much more will you pay?

This change could significantly increase the upfront expenses involved in a buy-to-let purchase. For example:

  • The Stamp Duty on a buy-to-let property worth £150,000 will increase from £500 to £5,000.
  • On a property worth £250,000, you'll now pay £10,000 in Stamp Duty, where previously you would have paid just £2,500.

Will the rule change affect every purchase?

The new rate applies to purchases in England, Wales and Northern Ireland* where, at the end of the day of the transaction, you own more than one property and are not replacing your main residence.

* If you're buying in Scotland, there is a similar tax (Land & Buildings Transaction Tax) but it isn't subject to these new rules.

If you already own a buy-to-let property, the new higher rate will apply to any additional properties you buy. However, the higher rate doesn't apply if you're replacing your main residence. If you're buying a new property to live in and selling your own home, you'll pay the usual rate, however many properties you own.

These examples illustrate when you'd pay the higher Stamp Duty on buy-to-let, and when you wouldn't:

Example 1: You are a buy-to-let investor with 10 residential properties in your portfolio. You also own your home, and you decide to sell your current home and buy a new one. At the end of the day of the transaction, you own 11 properties – your new home and your 10 buy-to-let properties. However, as you have replaced your main residence, you will not pay the higher rates of Stamp Duty.

Example 2: You own 10 buy-to-let properties, as well as your own home. You sell one of your buy-to-let properties and purchase another. At the end of the day of the transaction, you own 11 properties and haven't replaced your main residence, so you will pay the higher rate.

Example 3: You live in rented accommodation, and own one buy-to-let property. You sell your buy-to-let property and purchase another. At the end of the day of the transaction, you only own one property so you will not pay the higher rate.

Can I offset Stamp Duty costs against CGT?

Yes. Although an extra 3% in stamp duty represents a significant additional cost when you're purchasing a property, there could be a silver lining when you sell later on. When you sell your buy-to-let property, you can offset purchase costs against any Capital Gains Tax owed. So if you manage to sell the property at a profit, you will be able to claim back the extra initial cost.

How will the property market be affected?

The government's aim is to discourage people from purchasing buy-to-let properties, in the hope that this will increase the supply of homes available to first-time buyers. Of course, only time will tell exactly what the effects will be. Paul Hajek, of law and conveyancing firm Clutton Cox, says:

"Prices in the short term will enter a period of uncertainty with cat and mouse strategies between sellers and buy-to-let buyers until the market, as it invariably will, factors in the new Stamp Duty regime."

Tax relief changes from April 2017

Affects you if:

  • You have a buy-to-let mortgage, and
  • You're keeping the property beyond April 2017

The amount of tax relief you can claim on mortgage interest will be capped at the basic rate of 20%. Currently you can claim tax relief at your marginal rate, so higher rate taxpayers will see their tax relief halved.

Jargon buster: Your marginal rate is the rate at which you pay Income Tax on the next £1 you earn. Higher rate taxpayers currently receive tax relief at 40%.

When will the changes take effect?

The changes to tax relief will be phased in gradually over four years, from April 2017:

  • Tax year 2017/18: the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction.
  • Tax year 2018/19: 50% finance costs deduction and 50% given as a basic rate tax reduction.
  • Tax year 2019/20: 25% finance costs deduction and 75% given as a basic rate tax reduction.
  • Tax year 2020/21: all financing costs will be given as a basic rate tax reduction.

Changes to the way your income is calculated

Alongside the new restrictions on tax relief, the way you calculate your taxable income is changing. You will no longer be able to deduct the amount you spend on mortgage interest from your rental income, so your taxable income is effectively increased.

Could you be pushed over a tax threshold?

The fact that your total taxable income will now be higher could have significant implications. It could mean that some basic rate taxpayers are pushed into the higher rate tax band – but will only receive tax relief at the basic rate. It could also push some higher rate taxpayers into the additional rate band.

Remember that having a bigger income could affect you in other ways too. If your taxable earnings are more than £50,000 you won't be able to claim Child Benefit, and if you earn £100,000 or more you start to lose your personal allowance.

How will your finances be affected?

We've done some worked examples to show the potential impact of the changes on your buy-to-let returns.

Worked Example 1

You're a higher rate taxpayer with a taxable income of £50,000

Current situation

Rental income: £20,000

Mortgage interest: £13,000 (65% of rental income)

The mortgage interest is deducted so tax is only due on the £7,000 difference, at a rate of 40%, giving you a tax bill of £2,800.

£7,000 - £2,800 leaves you with a profit of £4,200.

Under new rules

Rental income: £20,000

Mortgage interest: £13,000 (65% of rental income)

Working out the tax is now slightly more complicated: 40% (your Income Tax rate) of £20,000 (your taxable income from the property) is £8,000, but the £13,000 mortgage interest qualifies for tax relief at 20%.

So subtract the tax relief: 20% of £13,000 is £2,600.

£8,000 - £2,600 leaves you with a tax bill of £5,400. Your profit is now £1,600, a reduction of £2,600.

If interest rates were to rise, things could get tricky:

Current situation

Rental income: £20,000

Mortgage interest: £16,000 (80% of rental income)

Tax is payable on the £4,000 difference, leaving you with a tax bill of £1,600 and profit of £2,400.

Under new rules

Rental income: £20,000

Mortgage interest: £16,000

Using the same calculations as in the previous example, the tax payable is now £4,800, leaving you with a loss of £800 (i.e. you're paying more in tax than you're earning as profit).

Capital Gains Tax deadline changes

Affects you if:

  • You own a buy-to-let property, and
  • You intend to sell it after 2019

Currently, when you sell a property that isn't your main residence (such as a buy-to-let property), you have to pay Capital Gains Tax (CGT) on any profit above your personal allowance (£11,100 for the 2015/16 tax year). Depending on your Income Tax band, you pay either 18% or 28% tax on anything above this amount.

From April 2019, instead of recording the tax you owe on your tax return and paying it by the January deadline, you will need to pay any CGT owed within 30 days of selling a buy-to-let property.

This could affect your short-term cash flow, so you'll need to plan ahead.

Ways to reduce your CGT bill

There are some expenses that can be used to offset your CGT bill, and by keeping a record of them you could reduce the amount that you have to pay. These include:

  • Legal and solicitors' fees
  • A loss made on a buy-to-let property in the previous tax year
  • Estate agent fees
  • Costs of advertising the sale of the property
  • Stamp Duty (as mentioned above)

What can you do to prepare for buy-to-let tax changes?

Because we know about these changes in advance, you've got some time to prepare your finances. You may be able to soften the blow by doing one or more of these things:

  • Remortgage: It's now more important than ever to make sure your mortgage rate is competitive. Compare the best rates and consider remortgaging your buy-to-let property in order to make the most of your returns.
  • Reassess your portfolio: If you own several buy-to-let properties, it may make financial sense to sell one in order to reduce your borrowing on the others.
  • Incorporate (become a company): Corporation tax is due to fall to 19% in 2017 and 18% in 2020, and if you invest through a company all costs can be offset against your rental income. However, when investing through a company, income can only be paid out to the directors as a dividend. From next April directors can receive £5,000 annually tax-free, with higher rate taxpayers paying a 32.5% dividend tax on any income above this amount. If you're considering this option, proceed with caution and seek financial advice.
  • Streamline: Make sure your finances are tax-efficient. If you're a higher rate taxpayer and your spouse doesn't work, consider transferring some or all of the rental income to them. This would allow them to maximise their tax-free personal allowance, reducing the overall tax payable.

The takeaway

If you're a basic rate taxpayer, you'll need to check whether the change in the calculation will push you into a higher rate tax band. You'll also need to plan ahead for the changes to Stamp Duty and CGT.

If you're a higher or additional rate taxpayer you could see a significant drop in your returns, but you can reduce the impact by planning ahead and making sure your buy-to-let mortgage rate is competitive as possible.

Buy-to-let mortgages: compare all of today's rates

Last updated: 12 January 2016