Wednesday, July 8, 2015

Renting Privately? Rent rises heading your way...

You would think the last thing the UK tax system needs is yet more complexity. But George Osbourne can't resist playing politics - with yet another budget announcement designed entirely around the headline it generates and to hell with the consequences.

And so in today's budget we have the hit on interest relief for buy-to-let landlords. As the budget report (para 1.191) says:
'The government will restrict the relief on finance costs that landlords of residential property can get to the basic rate of income tax. The restriction will be phased in over 4 years, starting from April 2017. This will reduce the distorting effect the tax treatment of property has on investment and mean individual landlords are not treated differently based on the rate of income tax that they pay. It will also shift the balance between landlords and homeowners.'
At this point I'm struggling to understand what this even means. The stuff about different treatment of landlords based on their tax rates is complete doublespeak - this _introduces_ differential treatment.

My understanding is that interest is currently a 100% allowable deduction against the rental income landlords derive from their letting business - it isn't a relief against tax paid, so who knows what the actual impact of this tax change is going to be. But I think we can safely assume that at soon as your income goes above the threshold for paying 40% tax, as well having to pay 40% tax on the additional income, if you have a buy to let property, something bad is going to happen to your ability to offset your interest costs against your rental income, and your effective marginal tax rate on each extra £1 of income will rocket - to 60% maybe - hard to tell - but yet another daft discontinuity in marginal tax rates depending on your circumstances, to add to the child benefit tax changes and other tweaking that now goes on at arbitrary points in the income scale.

The baying mob at this point is probably screaming, yeah, go George - stuff those evil buy-to-let landlords and their profiteering high rents. Personally, I think the baying mob is wrong. Rents are set by the balance between supply and demand (that's basic economics), not some grand collusion between millions of small landlords. Buy to let landlords frequently accept rents that represent a terrible return on a risky asset - 3-4% rental yield before costs in many cases - and interest is a very real cash cost to the landlord - it gets tax relief for a good reason.

But lets go with it, and assume you think this is a great idea in principle - let's predict what will now happen.

If you are an affected landlord, your marginal tax rate is now so high that buy to let property investment is not going to make much sense. If you are close to the higher rate threshold, you might decide to put more cash into your pension to go under the threshold, effectively getting relief on the pension contributions at your new much higher marginal tax rate and avoiding the new charge.

The more enterprising taxpayers who aren't in a position to do this, will look for other forms of tax avoidance. Maybe buy properties in a limited company wrapper, where interest will presumably still be a fully allowable expense. Cue dozens more pages in the UK's already overbloated tax code describing new emergency anti-avoidance measures the Chancellor will dream up to stop this wicked reluctance to submit to his will, and try to frame the circumstances in which a property sold to a limited company will be taxed as if it is owned by the person who owns some or all of the shares. This may work, but if so, it may also impact on companies like Property Partner, setup to provide easy access to the buy to let market for those that don't want to buy a whole property themselves (or will this just be an easy way round the new rules?).

But the most likely outcome is that many buy-to-let landlords on higher rate tax will choose to sell up. This will inevitably increase private sector rents. It may not be much consolation to those trying to buy properties either, as the lower funding from buy-to-let investors will probably also restrict the supply of new housing. Some new developments relying on the capital provided by buy-to-let landlords may not happen, or be seriously delayed, making things worse for everyone looking to buy or rent. There is also the regional aspect - in London I suspect almost all buy-to-let landlords are higher rate taxpayers, so the situation there for people looking to rent might deteriorate very rapidly.

There could be further knock on effects on the supply of private rental property, as even landlords not affected are aghast at the arbitrary nature of the changes made to the UK tax system, and decide their low returns on property don't reflect the risks, newly expanded to include political risks.

I am a buy to let landlord, but I think I am going to do OK out of this - my rent and my property value should go up in the medium term - I just pity people looking for private rental accommodation. I passionately believe that government should legislate in a way that really would seriously harm existing buy to let landlords investors like me - by making it easier for the market to build lots more houses, so that the market value of housing falls, reducing the cost to both buy and rent property - but I am still a landlord as sadly I don't believe they will do this any time soon. Indeed the change announced today will have the opposite effect - it will hit those currently providing a key source of funding for new housebuilding so reduce new housing supply, it will increase rents whilst creating a yet more complex tax code - this is another truly dreadful tax change.