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Stop Watch

The structural dilemma facing buy-to-let landlords

Buy-to-let landlords are having a rough time of it, with the Treasury introducing several tax measures that are beginning to eat into the profits of those with residential property portfolios in the UK.

When most people buy a house, they have to take out a mortgage, and historically residential landlords were able to declare rental income after they had paid their mortgage, cutting their tax bill by thousands of pounds.

However, this tax break began to be eroded at a rate of 25% a year from 2017/18 and January 2019 provided the first real data point for measuring the impact, with buy-to-let landlords seeing their tax bills significantly increase as a result.

Research by landlord insurer Paragon found that 58% of residential landlords experienced higher tax bills in 2017/18, compared to the previous year, with the average buy-to-let landlord's tax bill going up by £3,039.

When the figures for 2018/19 are published in January 2020, those bills will certainly have increased further due to landlords only being able to claim 50% mortgage interest relief. For 2019/20, the relief is down to 25% and by April 2020, it will be replaced by a tax credit that is based on 20% of their mortgage interest payments.

Nearly half (49%) of landlords who reported a higher than expected increase said they would make changes to their portfolio as a result, with selling property (24%), increasing rents (20%) and reducing borrowing (19%) all proving popular.

While figures from the Ministry of Housing, Communities and Local Government show that buy-to-let landlords with fewer properties are selling up at a rate of 4,000 a month, an increasing amount with larger residential portfolios are going down another route to avoid being stung by further reductions to mortgage interest relief.

Changing business structure

Professional buy-to-let landlords are adapting by changing their business structure, with research from Precise Mortgages showing an increasing amount of sole trader landlords moving to limited company status.

Almost two-thirds (64%) of landlords with more than four residential properties and plans to buy more in 2019/20 will do so as a limited company, compared to 21% who will purchase as individuals.

The dramatic rise in residential landlords changing business structure is down to a loophole: switching to limited company status enables landlords to continue to offset their mortgage interest against their profits.

This is because the mortgage interest relief only applies to individuals who pay income tax through self-assessment, while incorporating a company enables them to deduct any of their mortgage expenses from rental income to reduce their tax bills by considerably more than the basic-rate tax credit will at 20%.

Alan Cleary, managing director of Precise Mortgages, said:

"The buy-to-let market is changing and the switch to greater use of limited company status is one aspect of the development underlining the increasing maturity of the sector.

"There are good reasons why limited company buy-to-let is dominating the purchase market and we expect that will continue to be the case this year and next."

"Customers, however, need expert specialist support when buying as a limited company or considering switching to limited company status as there are considerable costs involved."

The tax situation

Incorporating a buy-to-let business could be cheaper as corporation tax would be paid at 19%, rather than paying income tax through self-assessment at rates as high as 40% or 45% depending on the taxpayer's marginal rate. Corporation tax is also due to be reduced from 19% to 17% from 1 April 2020.

However, it's also worth considering the costs involved with incorporating a business, such as being liable for capital gains tax by transferring a property portfolio into a company structure.

Therefore, incorporating a buy-to-let business only really makes sense if you're a professional landlord, while for landlords with a handful of properties it may make more sense to reduce your portfolio.

Get in touch to discuss changing business structure.