The buy-to-let property market is an enticing option for investors. Owning a holiday home or city pied-à -terre seems to have taken on a renewed cachet since Airbnb’s disruption of the hotel industry. As a financial planner, buy-to-let investing is a topic that regularly comes up with both my clients and peers, in particular the relative advantages and disadvantages that it may or may not have over stock market investing.
Property is often perceived as a less risky asset compared to stocks and shares. People consider it for capital growth, a method of providing passive income, or as a way of leaving a legacy for future generations. It can be an attractive proposition for those who prefer ‘bricks and mortar’. However, investors should be aware that it is a complex investment. Investing in property is not always as straightforward as it may first appear, and you should seek professional advice.
Investing in property is not always as straightforward as it may first appear, and you should seek professional advice.
Over the last few years, the buy-to-let sector has been hit by a number of changes to tax regulations, as well as the economic uncertainty of Brexit. As a result, according to The Financial Times in February this year and based on findings by Hamptons International, ‘landlords are buying fewer homes than at any time in the past nine years. Compared with 2011, when they accounted for nearly one in five homes purchased (18.7 per cent), they are now responsible for one in 10 (11.4 per cent) purchases in Great Britain.’
There’s good reason for this slow down, and before you commit to a buy-to-let investment, we invite you to weigh up very carefully the following important considerations:
Investing in Property for Capital Growth
Property prices are not necessarily as ‘safe as houses’. If you look across the country, prices have been stagnating in recent years, even in normally-robust London. In the last decade, we have had periods of poor growth and housing market recession. Over the long term, property is likely to have a net effect of growth, however this has to be weighed against ongoing costs.
Refurbishments and ongoing repairs
Big-ticket items like re-roofing or updating a kitchen can be expensive. You need to factor in the costs, management and time required for any refurbishment before rental can begin (bearing in mind the property will probably be vacant), as well as ongoing repairs as they occur. If the boiler breaks down in the middle of the night or there’s a leak in the roof, it’s the landlord’s responsibility to have it repaired as quickly as reasonably possible.
Additional Stamp Duty
In April 2016, the Government introduced an additional stamp duty on buy-to-let purchases, often described as the ‘3% surcharge’. However, the rate is not just limited to 3%. For properties with a purchase price of £125,000 the stamp duty rate became 3%, but this increases all the way up to 15% for the most valuable properties.
| Portion of Property Price | Stamp Duty to Pay |
|---|---|
| £1,500,001+ | 15% |
| £925,001 – £1,500,000 | 13% |
| £250,001 – £925,000 | 8% |
| £125,001 – £250,000 | 5% |
| £0 – £125,000 | 3% |
Buy-to-let and holiday home stamp duty rates
Restriction on Borrowing
After the 2008 economic crisis, high street banks toughened up their lending requirements. Most now require a would be buy-to-let borrower to show they have sufficient financial resources in addition to any potential rental income (normally a minimum of £25,000 p.a.) and borrowers will typically need to provide a deposit of between 20% and 40%.
Capital Gains Tax
There will be a Capital Gains Tax (CGT) position to consider. Normally when you sell your home (your main residence) you do not have to pay CGT on the profit, provided you have lived there throughout the entire period of ownership, because the gain is relieved (exempt) from tax. However, like business properties, buy-to-let properties are not exempt, and therefore Capital Gains Tax will apply in most circumstances.
Investing in Property for Passive Income
Any income from a buy-to-let is of course entirely dependent on having paying tenants, which is by no means guaranteed. You will likely have gaps in tenancy either in between long-term tenants or short-term lets, and during this time the property will not be bringing in any income, while you may still be paying a mortgage on it.
Landlords are buying fewer homes than at any time in the past nine years compared with 2011, when they accounted for nearly one in five homes purchased.
There are other costs involved too. You will still need to meet ongoing expenses such as Council Tax and utility bills. You may be paying an agent to manage the property, or other parties such as cleaners. Many would-be landlords plan to hand over the management of their property to an agency, thinking that this will make their lives easy, but in reality they fail to appreciate the full extent of their responsibilities and the possible costs and other implications of being a landlord.
Limited Fees and Deposits
The Tenant Fees Act came into force in June this year, prohibiting letting agents from charging tenants fees, including inventory check-in and check-out, referencing fees and tenancy renewal fees. Tenant deposits are also now capped at 5 weeks’ rent (previously they were typically 1.5 months’ rent). Agencies are already passing on these lost fees to landlords, but passing these on to tenants via a hike in rent may make your property unattractive.
Income Tax Bands
You will have to pay Income Tax on your rental income (minus your day-to-day running expenses). You will also have to pay Class 2 National Insurance if the work you do renting out property counts as running a business. If you are on the border of higher-rate Income Tax, you will need to consider how this may impact your overall tax position.
In 2017, the Government introduced a gradual reduction of the portion of mortgage interest which is deductible against rental income (phased in between 2017 and 2020). A new 20% tax credit is to be introduced from 2020 which will significantly increase tax bills for higher-rate taxpayers and, in some cases, will make it prohibitive.
| Tax year | Percentage of finance costs deductible from rental income | Percentage of basic rate tax reduction |
|---|---|---|
| 2017/18 | 75% | 25% |
| 2018/19 | 50% | 50% |
| 2019/20 | 25% | 75% |
| 2020/21 | 0% | 100% |
Landlord Legal Compliance
The Government’s website has a summary of the many other legal obligations of a landlord, which include being responsible for health and safety as well the rules governing protecting and returning a tenant’s deposit and providing the tenant with information in advance of the tenancy.
As a landlord you will also have to comply with the General Data Protection Regulation (GDPR) which came into force last year and can be complex. You’ll need to register with the Information Commissioners Office (ICO).
Landlord and Tenant Law is notoriously complex and ever changing. In our experience, most landlords would say that the legislation is skewed in favour of tenants. You can find yourself in breach of a regulation just because you didn’t know the law had changed, and this can mean large fines as local authorities ramp up their efforts to crack down on what they perceive as ‘rogue landlords’.
It’s the landlord’s responsibility to find and vet suitable tenants and check that legally they have the Right to Rent. This means that you have to inspect original documents to prove that tenants are permitted to live in the UK, ensuring they are genuine documents and keeping copies during the tenancy. You also have to bear in mind that it’s against the law to only check people that you think aren’t British citizens.
Tenancy Agreements
In 2017, Direct Line found that 58% of ‘go it alone’ landlords were using tenancy agreements that they’d adapted themselves from free online templates or from old agency contracts. The survey also found that 13% of landlords had experienced disputes in the past 2 years arising from a tenancy agreement. Worse still, 10% of landlords had no formal tenancy agreement in place at all!
Any income from a buy-to-let is of course entirely dependent on having paying tenants, which is by no means guaranteed.
A Tenancy Agreement is a vitally important legal document which should be prepared with legal advice to cover all eventualities.
Ending a Tenancy
For a number of reasons, you may find that you want to bring a tenancy to an end, perhaps because you want to sell the property or because the tenant has not been a good one – either failing to pay their rent, paying late or even damaging the property.
However, a number of recent legislative changes and proposals have made it increasingly difficult to get vacant possession of your own property. In April this year, the Government announced that it now intends to abolish something known as a Section 21 notice. A Section 21 notice is a method by which a landlord could get their property back with a two month notice period, without having to give a reason.
It’s also worth bearing in mind that changes in the law in 2015 (The Deregulation Act) introduced protection against retaliatory eviction for assured shorthold tenancy agreements. The provisions were designed to protect tenants (in situations where a tenant asks a landlord to carry out repairs to a property and rather than do the repairs, the tenant is evicted). However, one of the knock-on effects of this legislation was a rise in claims against landlords for retaliatory evictions, some of which have been found to be entirely spurious. This means that it’s essential to have a watertight and robust approach to ongoing repairs, and being away on holiday or not having the funds will simply not be enough to protect you from a potential claim.
Full details of new, alternative methods of getting possession of your property are not yet known. The main current alternative is what’s known as a Section 8, which requires proof that a tenant has broken the terms of their tenancy. It’s a slower and more expensive procedure and you may not have the requisite proof if you just want your property back.
Investing in Property to Create a Legacy
Leaving property to family can seem like an attractive option. However, bear in mind that if you own buy-to-let property and simply leave it in your Will to family, it will form part of your estate and be subject to Inheritance Tax. While there are other approaches you could consider, they are not necessarily as attractive as they may at first appear.
Inheritance Tax
While the recent introduction of the Residence Nil Rate Band gives individuals more scope to pass assets on to loved ones upon death whilst remaining below the Inheritance Tax threshold, this additional allowance only applies to the primary residence. In turn, this means that any rental property sits outside of this additional allowance, making it fully liable to Inheritance Tax should you utilise your standard Inheritance Tax Nil Rate Bands elsewhere.
Gifting Property During Your Lifetime
If you give property by way of an outright gift to a family member and you then survive seven years from the date of a gift, it is exempt from Inheritance Tax. However, if you die within that seven year period, there is a sliding scale of Inheritance Tax to be paid.
If you own buy-to-let property and simply leave it in your Will to family, it will form part of your estate and be subject to Inheritance Tax.
If the property is worth more than you paid for it, there will also be Capital Gains Tax to pay. The other downside of a gift is that once you’ve given the property away, you no longer have any control of it or any income derived from it.
Leaving Property in Trust
Whilst trusts can be a popular way of passing on property, they are not always tax-efficient and can be complex. You will almost certainly need professional advice.
The simplest trust is a bare trust which typically provides that the beneficiary has an immediate and absolute right to the assets from age 18. Once property is put within a bare trust, it is taxed as if it belongs to the beneficiary (i.e. perhaps your grandchild).
If they’re under 18, that probably means there is little or no tax to pay on any income as most children can earn up to a personal allowance of £12,500 tax-free (2019/20). However, there is an exception if it is parents rather than grandparents leaving assets to their children. In these circumstances, if the income is more than £100 per year the parent will have to pay tax on all the trust’s income.
There is a sliding scale of Inheritance Tax over seven years, as outlined in gifting property above.
A discretionary trust comes with a number of disadvantages. Firstly, although you have a greater degree of control and can indicate what you’d like to happen to the assets within the trust, the trust is still managed by the trustees ‘at their discretion’.
Assets in a discretionary trust will still be liable for Inheritance Tax if you’ve exceeded the nil rate band allowance and die within seven years.
Assets in a discretionary trust will still be liable for Inheritance Tax if you’ve exceeded the nil rate band allowance and die within seven years. More importantly perhaps, Inheritance Tax assessments are also mandatory on discretionary trusts every 10 years. This means that as soon as the value of the trust (original assets plus any returns and any payments made out of the trust) amounts to more than the nil rate band threshold of £325,000, you will start to pay tax on it at 6%. Future payments made to beneficiaries also then immediately become subject to Inheritance Tax, payable by the beneficiary.
Tax Rates for Trusts
For most trusts, investment interest and rental income up to £1,000 are taxed at 20%. Above £1,000, trust income is subject to tax rates of 45% for non-dividend income. What’s more, the normal tax-free annual income allowance of £12,500, the £1,000 annual personal savings allowance and £2,000 annual dividend allowance do not apply to trusts.
Finally, Capital Gains Tax also applies to trusts, with the tax-free threshold set at £6,000 in the 2019/20 tax year. Gains above this amount are taxed at 28% for residential property. All of which means this may not be the most tax-efficient investment vehicle or legacy.
Financial Planning
The above really underlines the importance of considering all options available as you create or refine your financial plan. If you have a buy-to-let property or are considering investing in buy-to-let, it’s important to consider all the possible ramifications and tax implications in light of your future aims and financial ambitions. Whether or not it is the right method of investment for you will depend on a multitude of factors.
Investing in property for capital growth can be unpredictable and you are no more guaranteed to get back what you invested than you are with other investments.
Investing in property for capital growth can be unpredictable and you are no more guaranteed to get back what you invested than you are with other investments. Property prices and income can fluctuate. Relying solely on property to achieve your objectives may not generate the results you need and could potentially leave you with an unnecessarily high tax bill.
Like any business enterprise, becoming a landlord shouldn’t be entered into lightly. It takes patience, time and ongoing investment to keep rental properties. So, whilst property may seem like an attractive option, it’s vitally important to consider all of your investment options and compare the risks and rates of return, the tax implications, and the work involved in keeping that asset ticking over.
At Progeny, our team of professionals are experts in financial planning, investing, residential law and tax. Our multi-skilled teams are uniquely qualified to advise on buy-to-let property from a holistic perspective. If you would like further clarification on any of the above, or would simply like to discuss your investments, please get in touch.
