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Which tax changes are ahead for buy-to-let investors?

Amid tighter legislation, a higher tax burden and rising interest rates, many landlords are considering the alternatives. For some, measures announced in the Budget provide additional reasons to sell up.

| 8 min read

An increasing regulatory burden and a tightening tax net has already seen many landlords re-evaluate their property investments and prompted some to exit. Meanwhile, diminished returns from higher mortgage costs and a greater income tax burden are affecting those that have stuck it out.

This direction of travel was further confirmed by Chancellor Jeremy Hunt, in the Spring Budget with some new incentives for buy-to-let investors to sell up.

Budget changes

Of the two major Spring Budget changes affecting landlords one was a carrot, the other a stick.

The carrot came in the form of a reduced top rate of capital gains tax (CGT) charged on the sale of investment properties. CGT is charged on the profit landlords and second homeowners make on a property that has increased in value when they sell. The tax currently applies on secondary properties at basic and higher rates respectively of 18% and 28%, compared with 10% and 20% for other assets. However, the higher rate of 28% will fall to 24% in the new tax year from April 6th. The rate for basic rate taxpayers will remain the same at 18%.

Mr Hunt said Treasury analysis suggested a lower rate of tax would increase sales, and it could have the effect of increasing the numbers of properties available to those looking to buy a home.

The cut will be partly watered down, however, as the annual CGT allowance, the first part of your annual profits that you pay no tax on, is falling next tax year from £6,000 to just £3,000. Unlike holding readily tradable assets such as shares that can be sold in stages, it is not possible to use CGT allowances over different years to minimise tax when you sell a property.

Find out more about CGT

How much CGT could landlords save?

With property gains often far exceeding the annual allowance, most landlords end up paying CGT even after offsetting property related expenses, such as the costs of conveyancing and stamp duty. This means the cut to the CGT rate could result in a big tax saving when they come to sell.

  • Currently, someone selling a second property for £400,000, having purchased it for £300,000, will make a taxable gain of £94,000 after their £6,000 annual allowance, assuming it is not already used through the disposal of other assets.
  • From 6th April, the taxable gain on the same transaction would rise to £97,000, as the annual allowance is cut to £3,000.
  • However, this tax year a higher rate taxpaying landlord charged at 28% on a £97,000 gain would have paid £27,160 in CGT, but in the new 2024/25 tax year the equivalent landlord would pay £23,280, a saving of £3,880.

Landlords selling properties tend to mostly pay the higher rate of CGT, rather than basic rate, because gains are added to taxable income to determine the rate it is charged at. So, even if someone is a basic rate taxpayer for income tax purposes, a sizeable capital gain is likely to push them substantially into the higher rate for a second property sale.

Holiday let reliefs abolished

Meanwhile, the aforementioned stick came in the form of the surprise abolition of the furnished holiday lets (FHL) regime, which offers tax advantages to those who let out a property as a holiday home.

Presently, landlords who use the regime can deduct the full cost of their mortgage interest payments from their rental income, which is more generous than for standard buy to lets, and use capital allowances that offset the cost of providing furniture and appliances. In addition, FHLs qualify as UK relevant earnings with full tax relief for pension contributions, unlike other property or investment income, and there is the potential to pay lower capital gains tax when a property is sold.

Mr Hunt said holiday lets reduce the availability of housing stock for purchase or long-term rental. In some communities in tourist areas this has become a major problem for locals and seasonal workers.

FHL status is to be abolished in April 2025 with properties brought into line with standard buy to lets. For some owners it may be worth considering whether a FHL should be sold before April 2025 to attract the potentially favourable business asset CGT rate of 10%.

Financial challenges for buy-to-let investors

The combination of these two policies could be seen as another move to push private landlords out of the market and release more properties either for long-term lettings or for sale.

Many buy-to-let investors have turned to the holiday let market to increase profits following the reduction in mortgage interest relief on residential lets. The dismantling of the FHL regime, plus the incentive to sell and pay a lower CGT rate ahead of the 2025 deadline, could see more rental properties come onto the market. However, those incorporated as a limited company will be unaffected.

Going forward, the evaluation of any existing or prospective buy-to-let investment ultimately comes down to the prospects for income, growth in income, and the potential for capital appreciation, as well as the tax treatment. As such it needs to be compared with the returns available on other assets.

Higher inflation and interest rates increased the ‘risk-free rate’ of return available on safe investments such as cash or government bonds. This depresses the value of all assets as investors demanded higher return for taking risk. The same principle should apply to rental property. An acceptable post-tax and expenses income yield in buy-to-let may have been as low as 3-4% in an era of close-to-zero interest rates, but what should it be now cash rates are much higher? Seen through this lens, many properties may now not stack up as good investments, even where rents are still rising.

Other investments to consider

  • Funds, shares and other investments can arguably offer better alternatives to buy-to-let for long-term capital growth and income without the aggravation, as well as much greater opportunity for diversification – spreading your money around to reduce risk. Yields on UK shares for instance average around 3.75% and it is possible to generate income significantly more than this by focusing more on dividend-paying companies. All yields are variable and not guaranteed. Markets, it must be pointed out, have their downs as well as ups, but if you are appropriately invested and sufficiently diversified then income tends to be much more stable than capital value.
  • When investing in the stock market or other assets it is possible to minimise tax very effectively. One option is to pay into a pension such as a Self-Invested Personal Pension (SIPP) and get tax relief on the contributions. Investments housed in a pension are also free from income tax and capital gains tax. From age 55 at present, you can then start accessing your pension to provide yourself with an income.

Find out more about the alternatives to the buy-to-let market.

Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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