Wet Summer Start but George Osborne Delivers a Dry Tax Charge Though Holiday Homes Escape
Does the restriction of buy to let mortgage interest relief cross a line in the sand?
As I am writing this the sun is out and it’s a beautiful morning which rather spoils the headline but there are clouds gathering for owners of buy to lets following the announcement in the budget that mortgage interest relief will be restricted to the basic rate of tax i.e. 20%. This will result in a ‘dry’ tax charge which is tax on income that you haven’t actually made.
Now you can argue that there have always been plenty of these charges in the system- if you receive a benefit such as a company car, health insurance or a share allocation there is tax due on the value of the benefit as determined by HMRC so you pay tax without receiving the income as cash. There is a fundamental difference though because you did receive the benefit.
There hasn’t been much fuss made but I think that the buy to let restriction crosses a very fundamental line in the sand. Throughout the years that I worked in the finance industry there was a simple answer for clients bemoaning a large tax bill- if you owe the tax you must have earned the money. This will not be true in future for buy to let landlords
Although lending rules have tightened it’s still pretty common for a buy to let owner to have a property that only breaks even after costs or even loses a little each year. They may have let out their old house or made an investment using a discounted rate that has now expired. A £180,000 property with £130,000 mortgage at 4.5% would be incurring £5,850 in interest so it’s easy to see how a rent of say £700 a month would fail to cover this after agents fees, maintenance etc and an empty month or two would see it making a loss. A 1.5% rise in interest rates (hardly armageddon) would see interest rise to £7,800 and you would definitely be losing money.
Traditionally many landlords have been fairly relaxed about this sort of situation thinking that it’s a long term investment, the property is going up in value and if you have a good tenant that’s been with you a long time the situation is relatively hassle free.
The new proposals are being phased in over 4 years but at the end of the process a landlord in this situation could face a tax charge of around £1,500 on money they haven’t made if they are a higher rate taxpayer- you owe the tax even though you didn’t make the money.
The budget rhetoric talked about investors not competing fairly with first time buyers due to the tax relief situation but this is spin at it’s finest (or worst). It’s a fundamental principle of business, in fact of life that profit equals income less expenses and if there is unfairness it’s in the new rules.
The Irish government used a complete restriction on interest relief to bring their housing boom to a halt and you have to say it was certainly effective or at least one of the factors in the subsequent property crash.
I understand that we need to raise revenue to run the country responsibly but it’s hard to see the logic behind reducing incentives to provide much needed housing.
Commercial holiday lets are not subject to the new rules as long as they are operating as a business, however owners will have to think carefully about winter lets as a 6 month residential tenant would qualify the property as a buy to let and my understanding is that the tax charge would apply for the whole year as well the loss of small business rate relief making the landlord liable for council tax in the holiday letting period.