Essential buy to let guide for 2016 and beyond

We summarise key changes occurring in the buy-to-let market in the coming years and your options for continuing to invest successfully.

You can quickly get information on the changes buy-to-let has undergone in 2016 and will be subject to in 2017.

We hope you welcome the information shared here, but we do not provide tax advice so you should discuss your circumstances and any proposals with an accountant or tax adviser with relevant expertise.

Expert view: Andrew Turner, CEO, Commercial Trust

Andy Turner"If approached correctly, buy to let can still be a profitable alternative to other forms of investment. Though the playing field may change, informed investors who remain vigilant and willing to adapt their strategy as required can still be successful."

UK to exit European Union

Friday 24 June saw over 30 million people vote to decide on whether the UK would remain a member of the European Union. The collective decision, by just 52% of the vote to 48%, was to leave.

What next for the UK?

The UK is still a member of the EU – for now. The referendum result is not legally binding on the UK Parliament. The formal withdrawal begins only when the government notifies the EU under article 50 of the Lisbon treaty of its intention to leave.

Prime Minister Theresa May, who succeeded David Cameron following his post-referendum resignation, does not wish to trigger the UK’s formal withdrawal without a period of negotiation with the EU.

She has, however, stated that “Brexit means Brexit”. The government is keen to emphasise its commitment to the UK’s departure from the EU. But when and how this will occur is, at present, far from certain.

Bank of England cuts interest rates

Just under six weeks after the referendum, on 4 August, the Bank of England announced a range of monetary stimulus measures.

Expecting “markedly” subdued growth over the next two years, it cut the Official Bank Rate to its all-time low. And to ensure that commercial banks pass on the savings, it also announced measures to boost the supply of money in the economy.

Read more: Bank of England cuts interest rates by 0.25%

Prospects for the housing and mortgage markets

Industry data for the second quarter of 2016 shows that mortgage lending fell compared to the first quarter. The most likely reason for this is the higher rate of stamp duty introduced on April 1, which had a marked effect on buy-to-let lending volumes.

Nevertheless, mortgage lending as a whole was higher year on year. This shows that the market was still strong in the run up to the EU vote.

Prior to the referendum, buy-to-let lenders were in furious competition for business. Rates have been falling and criteria improving. This pattern has continued, with banks seeking to attract the custom of hesitant buyers who are unsure which way things will go.

For landlords who are looking to switch their mortgage rate, or who intend to continue investing, now could be an excellent time to find a great deal on a buy-to-let mortgage.

Remember that the fundamental market factors have not changed. A shortage of property and rising demand from tenants means that there will always be a need for professional private landlords who offer good-quality rental properties.

Stay up to date with the latest market news

Landlords now pay more tax on property purchases

As of 1 April 2016, higher rates of stamp duty land tax (SDLT) apply to purchases of second homes and buy-to-let properties worth over £40,000.

For landlords in Scotland, a 3% land and buildings transaction tax (LBTT) surcharge is levied instead, see below for details.

There is a 3% surcharge on all bands, including the ordinarily tax-free band for properties under £125,000. The surcharge applies to both individuals and non-natural persons such as companies. This is irrespective of the  size of the transaction or the buyer’s existing portfolio.

Will I pay the higher rates?

The government has provided a useful flowchart to show under which circumstances a buyer pays the higher rates of SDLT:

Stamp duty diagram

They have also given examples where the higher SDLT rate will or will not apply. We have summarised the examples below.

Where the higher rate will not apply:

  • where an individual sells their main residence and buys a new one
  • where an individual buys their first property, irrespective of whether it is a main residence or a rental property
  • where an individual who lives in rented accommodation sells one rental property and purchases another
  • where an individual who owns a second home sells their main residence and buys another
  • where a buy-to-let investor with more than one rental property sells their main residence and buys another

Where the higher rate will apply:

  • where an individual who owns their main residence buys a rental property
  • where an individual buys a new main residence and lets out their old residence instead of selling it (known as a let-to-buy transaction)
  • where an individual buys their first property, which is a rental property, and then at a later date buys a main residence

Further points for clarification

  • Whether the higher SDLT rate will apply depends in part on how many properties you own at the end of the day of the transaction. So even if you have owned properties in the past, if you only own one property after the transaction then you will not pay the higher rate.
  • Whether the higher SDLT rate applies also depends on whether you are replacing your main residence. In the example of the individual who owns a rental property and moves into their first home from rented accommodation, the higher SDLT rate applies, because they are not replacing a residence they already owned.
  • If you are moving home but keeping your old home as a second home or a rental property, you will pay the higher rate on your new home. The main residence that you are replacing must also be sold for the lower rate to still apply.
  • If the sale of your previous main residence occurs after the purchase of your new main residence, the higher SDLT rates will apply. But you will be able to claim a refund of the extra tax paid if you sell your previous residence within 36 months.

Calculate your stamp duty costs

The nature of the new framework means that HMRC will levy the higher rate on the majority of buy-to-let transactions. However, there are ways to mitigate the added costs.

Read more: How to beat the buy-to-let stamp duty surcharge

Landlords in Scotland also face a higher transactions tax

The higher SDLT rate applies to landlords in England, Northern Ireland and Wales. In Scotland, a 3% land and buildings transaction tax (LBTT) surcharge is levied instead.

As in England and Wales, the surcharge applies to transactions made on or after 1 April 2016.

Land and Buildings Transaction Tax (Amendment) (Scotland) Act 2016

Limited company transfers will also attract the higher stamp duty rate

Limited companies and their directors are separate legal entities. Thus, limited company transfers are arm’s-length transactions, and subject to capital gains tax and stamp duty.

Private individuals would continue to pay the ordinary rates of stamp duty on their first property purchase. But the government believes that giving companies the same benefit will encourage tax avoidance.

As a result, HMRC will levy the higher rate of tax on a company’s first residential property purchase. This will include transfers from individual ownership into a limited company structure.

"It might seem like landlords are between a rock and a hard place at present, thanks to the rapidly changing economic, financial and legislative environment in which they operate. But it is important to not lose hope. Instead, focus on the fundamental truths that underpin their place in the UK’s housing sector."

- Andrew Turner

Further changes to buy-to-let tax from April 2017

Income tax relief for buy-to-let mortgage interest will be withdrawn between 2017 and 2020. In its place, landlords will be able to claim a 20% tax reduction.

Read more: Landlord tax relief restricted in July 2015 Budget

The changes will see most 40% and 45% taxpayers pay more tax on their rental income. And because any landlord who pays mortgage interest will see their taxable income rise, some 20% taxpayers will also pay more.

Read more: Will basic rate landlords be forced in to higher tax bands?

Gov.UK: Restricting finance cost relief for individual landlords

Investors should consult with a professional accountant or tax advisor to find out how these changes will affect them.

How might this affect me in the short term?

The mortgage you choose now could be affected

The buy-to-let relief withdrawal will begin in April 2017. 100% tax relief will fall to 75%, with the remaining 25% subject to the basic rate reduction.

Most buy-to-let mortgages have an introductory period of at least two years. Thus, the changes could affect a mortgage you take out now, particularly if you borrow on an interest-only basis. Be sure to consult with your mortgage advisor to ensure that you choose the right product.

Read more: Buy-to-let tax relief and interest-only mortgages

“Housing in the country is in dramatically short supply. Because of dwindling social housing stock and the government’s failure to encourage house building, the private rented sector remains a necessary part of the market. And buy-to-let landlords are a vital part of the private rented sector, having helped the market to recover more quickly than any other tenure since the recession and provided homes for millions of tenants."

- Andrew Turner

What are my options?

It may be possible to plan a strategy to mitigate the impact of the 2017–20 tax changes.

Below we examine four options: transferring properties to a limited company, making future purchases through a limited company, reducing debt by selling or overpaying, and continuing as normal.

I’m thinking of transferring some or all of my properties

Transferring an asset into a limited company qualifies as an arms-length transaction. As such, both capital gains tax (CGT) and stamp duty may be payable, and calculated at open market value.

Read more: CGT: losses and deductions

Read more: CGT: lettings and private residence relief

Read more:Stamp duty: thresholds and rates

Speak to a tax advisor or other financial professional to determine whether transferring your portfolio to a limited company is the right option for you.

I’m thinking of making future purchases through a limited company

To avoid CGT and stamp duty exposure, you might prefer to keep your properties in your individual name and make future purchases through a limited company.

Buying to let through a limited company can afford some tax advantages. But it also entails additional costs and administration when compared to investing as an individual.

Whether this is the right choice will depend on your circumstances and plans for the future. Discuss your options with a professional financial advisor before moving forward.

Read more: Pros and cons of buying to let through a limited company

Read more: How to set up a limited company

I’m thinking of selling some or all of my properties, or otherwise reducing my debt

Disposing of underperforming assets can reduce the debt elsewhere in your portfolio and could help to reduce your exposure to income tax when the phase-out of relief begins in 2017. It could also lower your running costs.

Alternatively, you may have funds elsewhere that you can use to repay some of your mortgage debt and reduce your interest repayments.

In either case, be sure to check the terms of your mortgage agreement. Many lenders will levy early repayment charges (ERCs) if you repay some or all of your capital before the agreed-upon date.

Also consider speaking to a financial advisor to see if downsizing your portfolio is the best option for you.

I’m thinking of carrying on as before

Adaptation is part of running any long-term business such as buy to let. But sometimes, only minor adjustments are required to stay ahead of the curve.

Though costs may rise for some, property will remain a viable investment for those with the right attitude, expertise, and willingness to adapt and adjust their strategy as required.

As with any of the options described above, remember that obtaining advice from accountancy and mortgage experts can help to give you the best chance of proceeding successfully with your investment.

Other changes to be aware of

As well as changes to stamp duty and buy-to-let tax relief, the buy-to-let sector will see a number of other fiscal and legislative changes in the coming years.

New energy efficiency regulations for landlords

Tenants’ right to request energy efficiency improvements

New rules came into effect on 1 April 2016 that allow tenants to request their landlord’s consent for them to make energy efficiency improvements to their home. Landlords cannot unreasonably refuse consent.

The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015: when a landlord may refuse consent

The legislation only covers ‘relevant’ improvements. An improvement is relevant if it can be financed at no cost to the landlord, though the landlord may still contribute to the cost if they wish.

Furthermore, landlords may refuse requests to make improvements that would reduce the value of the property by more than 5%. Where third party consent is required, it must be obtained.

Landlords must respond within one month. They have the opportunity to provide a counter proposal that suggests one or more alternative energy efficiency improvements.

Minimum energy efficiency ratings for privately rented properties

From 1 April 2018, all privately rented properties that are subject to new or renewed tenancies must have a minimum energy performance rating of E. In effect, it will be an offence to rent out a property with an EPC rating of F or G. This will apply to all existing tenancies from 1 April 2020. There are, however, a number of exemptions outlined by the Government, which can be found here.

The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015, Part 3: Minimum level of energy efficiency

If landlords breach these regulations, the tenancy agreement will remain in place, but they may be forced to pay a civil penalty of up to £4,000.

Regulation may increase in the buy-to-let mortgage market

In March 2016, the Prudential Regulation Authority (PRA) concluded a review of underwriting standards in the buy-to-let sector. It discovered what it believes is a risk of relaxing standards as lenders seek to expand their market shares.

On 29 March 2016, the PRA launched a consultation on whether to tighten regulation for buy-to-let contracts. New rules would include tougher affordability assessments that may make it more difficult for landlords to get a mortgage. The consultation closed on 29 June 2016.

The PRA operates alongside the Financial Conduct Authority (FCA) in the regulation and supervision of mortgage firms. The FCA oversees consumer buy-to-let lending and lending to certain other individuals. The PRA’s proposals apply to lending outside this remit.

Although in August, Sky News reported that the FCA is considering intervening in the non-PRA-supervised part of the market.

As of the 1 January 2017, PRA-regulated lenders have had to adopt tighter mortgage affordability criteria, which is set at 145% at a rate of 5.5%. 

Example:

If you had a rental income of £1,000, with previous stress test figures of 125% at a rate of 5%, you could take out a maximum loan of £192,000.

From January 2017, the same rental income of £1,000 with a 145% at a rate of 5.5% will now give you a maximum loan of £150,470.

The PRA said that:

“Rental income is an important factor when determining the ability of buy-to-let landlords to service their debt. Accordingly, a widespread market practice in the buy-to-let lending market is to use the mortgage’s interest coverage ratio (ICR) in assessing affordability."

Fixed rate mortgages of 5 years or more and mortgage terms of 5 years or less, fall outside of the PRA’s stated underwriting changes. 

Not all lenders are regulated by the PRA, and some lenders have not adopted the tighter affordability criteria. 

New European legislation limits product availability for some investors

The European Mortgage Credit Directive (MCD) took effect on 21 March 2016. It requires lenders in the UK to distinguish between buy-to-let lending to businesses and to consumers. The latter group is now supervised under the Financial Conduct Authority’s new ‘consumer buy to let’ (CBTL) framework.

All borrowers will have to answer additional questions during the application process so that their advisor may determine which regulatory status should apply to them. As not all lenders are offering mortgages to CBTL clients, borrowers who fall into this category will be unable to access some products.

There will be other changes for CBTL clients:

  • Consumers will receive standardised information about products recommended to them.
  • Lenders must issue a binding offer at some stage in the application that, unlike a decision in principle, is non-conditional. They will only be able to rescind a binding offer if they discover a material change to the application or that the applicant gave misleading information.
  • Consumers will have a minimum of seven days to reflect on a binding offer. They may cut this period short if they wish, but the lender may not.
  • The FCA will regulate second-charge mortgages under its mortgage regime, rather than the consumer credit regime it used to fall under.
  • Lenders must provide further safeguards for borrowers whose salary is in a different currency to the mortgage they are applying for (foreign currency loans). This includes accounting for exchange rate fluctuations. Some lenders have withdrawn from foreign currency lending as a result.

Your mortgage advisor will take a full account of your circumstances and requirements and guide you through the most suitable product options.

‘Right to rent’ law now in force for the whole of England

All landlords in England must now check the immigration status of their prospective tenants. This rule applies for all tenancies that began on or after February 1 2016. It also applies to individuals renting a room in their own home to a lodger.

Landlords should familiarise themselves with the new legislation in order to be compliant with these requirements, whilst being careful to avoid discrimination.

The latest Home Office guidance on the right to rent scheme can be found in the links below.

Mandatory licensing to be extended to smaller HMOs

The government has proposed extending the mandatory licensing of houses in multiple occupation (HMOs) to smaller properties. Landlords who rent out shared properties that are not already licensable should be aware of the changes and watch for developments.

The consultation on Extending mandatory licensing of houses in multiple occupation and related reforms closed on 18 December 2015. DCLG will publish the outcome once it has finished analysing feedback.

New planning rules for HMOs in Wales

As of February 25 2016, Welsh local authorities are able to manage the development of HMOs with six or fewer occupants.

The Town and Country Planning (Use Classes) (Amendment) (Wales) Order 2016 introduces to the original 1987 Order a new class, C4, for HMOs housing up to and including six residents.

In addition, the Town and Country Planning (General Permitted Development) (Amendment) (Wales) Order 2016 amends the original 1995 Order to include a permitted change from a C4 to a C3, meaning that landlords in Wales can freely convert HMOs that house no more than six residents into a single-unit dwelling.

A change from a C3 to a C4, however, may, at the relevant local planning authority’s discretion, require planning permission. An application for this will be subject to the recently increased £380 fee, and may not be permitted.

Dwellings housing seven or more occupants remain classed as sui generis (uncategorised, or ‘of its own class’). Planning permission is always needed for material changes from or to a sui generis use.

Landlords in Wales must register under a new licensing scheme

Landlords in Wales have until 23 November 2016 to register themselves and their properties under the new Rent Smart Wales scheme in order to comply with the Housing (Wales) Act 2014. In addition, all agents and self-managing landlords must become licensed, for which they will need to be adequately trained in order to declare themselves ‘fit and proper’ to manage rental properties.

www.rentsmart.gov.wales

CGT payment window to reduce to 30 days from April 2019

At present, capital gains tax (CGT) is payable by 31 January for transactions conducted in the preceding tax year. This gives a window of between 10 and 20 months to pay the tax owed.

From April 2019, individuals who need to pay CGT on the disposal of a residential property will have just 30 days following the completion of the sale to do so. This gives landlords far less time to account for any applicable deductions and reliefs, and could also affect cash flow.

Gov.UK: Spending Review and Autumn Statement 2015 – capital gains tax payment window

This information should not be interpreted as financial advice. Buy to let mortgage rates are subject to change. We can only make recommendations for products we broker. Seek tax advice from a professional.

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