Landlords face an eye-watering effective tax rate of 66 per cent on rental profits when mortgage interest relief changes come into full effect, figures calculated for This is Money and MailOnline Property reveal.
The numbers highlight why the tax clampdown on buy-to-let has left many landlords questioning whether their property investments are still worth it given the extra financial costs they now face.
Realising that they are paying such a high effective tax rate may push yet more to quit buy-to-let and push rental prices even further amid a shortage of properties, landlord organisations fear.
This three-bed house in Hull, East Yorkshire is for sale for £140k and comes with a long-term tenant in situ
The key to the sky-high tax charge is that the removal of full tax relief on mortgage interest and introduction of a 20 per cent tax credit, also involves a trick that will see buy-to-let investors’ tax calculated on rental revenue, rather than their profit after finance costs.
This will exacerbate the effect of the changes for higher rate tax payers with buy-to-let mortgages, meaning that from 2020 they will hand over two-thirds of their rental profit.
The change in tax relief is being phased in over four years – ending in the 2020 to 2021 tax year.
For higher rate taxpayer landlords, who make up a large chunk of the market, our exclusive research compiled by accountants Blick Rotherberg shows they will end up paying an effective tax rate of 66 per cent.
The figures are based on annual rental income profit of £5,850 on a £200,000 property with a £120,000 mortgage.
Under the previous system a landlord would get full mortgage interest tax relief, deducting their annual mortgage interest of £3,300 from their £5,850 rental income and paying 40 per tax on the lower figure of their £2,550 rental profit.
But under the new system, they are instead charged 40 per cent tax on the higher figure of their £5,850 rental income, amounting to £2,340.
A 20 per cent tax credit on their mortgage costs – worth £660 – delivers a total tax charge of £1,680, which amounts to 66 per cent of their £2,550 profit from rent received after paying mortgage costs.
Tenants in situ: This three-bed house in Torquay, Devon, is for sale for £140k
As well as dealing with extra regulation and lending restrictions, landlords also now have to deal with a three per cent surcharge on stamp duty when they buy a new investment property.
These figures are based on running a property and have not factored in the additional stamp duty costs of purchasing a buy-to-let.
Nimesh Shah, of accountants Blick Rotherberg – who carried out the research for MailOnline Property – suggested that the figures reveal a total after-tax profit of £870 a year on a typically priced £200,000 property, which has a mortgage of £120,000.
Mr Shah explained: ‘These figures show no surprises in the sense that landlords earn more money by renting it out.
‘However, what will be a surprise is that it is perhaps not as much more as they thought once their costs and the new tax changes are taken into account.
‘Landlords with a typically-priced property could end up making a profit of less than £900 a year, plus any capital growth.
‘They will be relying on capital growth to get a return on their investment as the income isn’t worth it. It is not surprising that landlords are deciding to leave the sector.’
How the figures were calculated
How the figures map out over the period tax relief is cut
The reduction in tax relief is being phased in over four years and so the calculations are shown across five columns, including one column before the changes were introduced.
This first column shows the total return a higher-rate taxpayer landlord could make, based on no reductions in tax relief.
The rental return figure remains the same across all of the five tax years from the tax year starting 2016 to the tax year beginning 2020.
But the introduction of the tax credit, scrapping of full mortgage interest relief and charging of tax on rental revenue, means progressively less for the landlord.
To get a total return, the after-tax profit is added to an assumed annual capital growth of £10,000 – 5 per cent a year on a £200,000 property in the first year.
The research is based on a higher rate taxpayer with an unfurnished rental property that is worth £200,000.
The landlord has a buy-to-let mortgage of £120,000 on a rate of 2.75 per cent and monthly mortgage repayments of £275 – the equivalent of £3,300 a year.
The rental income paid by the tenant is £750, which produces total rent of £9,000 a year, this is reduced down to £5,850 by costs that can be offset against tax, of £250 a year for buildings insurance, repairs and maintenance of £500, a lettings agent management fee of £900 and an annual £1,500 for finding a new tenants and one month’s missed rent.
This two-bed house in Folkestone, Kent, is on the market for £130k and has a tenant in situ
The tax clampdown on landlords is feeding through to tenants as a shortage of supply means landlords can secure higher rents.
And for those landlords who are remaining in the industry, higher rents is a chance to recoup of their additional tax losses.
David Cox, chief executive of ARLA Propertymark – the trade body for the letting agents – explained: ‘Buy-to-let investors are being pushed out of the market by increasing costs and continued regulatory change, and new landlords are being deterred from entering.
‘Last month, an average of four landlords took their properties off the market per branch, up from three this time last year – and as supply falls, competition among tenants increases, which pushes up rent costs.
‘Almost a third saw their rents rise last month, and although this figure was down from June, it’s still far too high.
‘To put tenants back in the driving seat, we need more homes available to rent, and the only way this will be achieved is if the Government makes the market more attractive for buy-to-let investors.’
To highlight the impact, the research also looked at letting a property compared to just leaving it empty, where expenses such as hiring a letting agent to find a tenant and paying for general repairs and maintenance would be removed.
This three-bed house in Peterborough, Cambridgeshire, is on the market for £149,995 and is currently let at £595 a month
Separate figures from ARLA Propertymark showed that the number of tenants looking for new homes has increased, while supply of rental properties has dwindled.
It said the number of new prospective tenants registered per letting agent branch increased from 71 in June to 79 in July, the highest level seen this year.
At the same time, the supply of available properties dropped from 191 in June to 184 last month, while the number of tenants experiencing rent rises in June reached 35 per cent in June and 31 per cent in July.
Experts that the current situation will lead to further pain for tenants, with rents expected to increase even higher.
Adam Male, of lettings agent Urban.co.uk, said: ‘While numerous legislation amendments and implementations have looked to reduce the cost that the nation’s tenants are facing, penalising landlords in the buy-to-let space has barely made a dent in the number of people facing a rent increase.
‘What’s more, the continued decline of properties available in the sector due to an exodus of landlords, and the highest level of demand seen this year will further tilt the supply-demand imbalance and inevitably see prices grow ever higher.’
Tenant in situ: This three-bed house in Leicester, in the East Midlands, is for sale for £140,000