2020 Vision for Landlords

by Mark Alexander

23:30 PM, 12th July 2015
About 4 years ago

2020 Vision for Landlords

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2020 Vision for Landlords

Will Buy-to-Let still make sense in 2020 when the new tax rules come into full effect? 2020 Vision for Landlords

I have done some number crunching based on 5% gross yield and 5% per annum capital growth.

Here’s a summary:-

Property value say £150,000

Rent of say £7,500 per annum (5% gross yield).

Cost of management, maintenance, insurance etc. = 25% of rent, i.e. £1,875.

Gross taxable profit = £5,625.

Average yearly increase in value £7,500 (i.e. 5% of capital value).

Total return £13,125.

Now let’s add in a financing strategy, say 5% interest on a 75% LTV loan.

Mortgage amount: £112,500

Interest at 5% = £5,625

Tax relief at 20% of interest = £1,125

Deposit required £37,500

The outcome:

Gross rental income = £7,500

Deduct £1,875 for management, maintenance insurance etc.

Deduct £5,625 for interest costs

Rental cashflow before tax = £0

Taxable profit = £5,625 which equates to tax payable as follows

  • If you are still a 20% tax payer after factoring in your £5,625 of taxable profit then you will pay an extra £1,125 of tax, but you will have a tax credit of £1,125 to offset against that due to your tax relief on buy-to-let interest. In other words, your rental cashflow before tax will remain £0 after tax.
  • If you are a 40% tax payer after factoring in your £5,625  of taxable profit (in other words your total taxable income is more than £43,000) then you will pay an extra £2,250 of tax but you will have a tax credit of £1,125 to offset against that due to your tax relief on buy-to-let interest. In other words, your £0 of rental cashflow before tax will become -£1,125 negative after tax
  • If you are a 45% tax payer after factoring in your £5,625 of taxable profit (in other words your total taxable income is more than £150,000) then you will pay an extra £2,531 of tax but you will have a tax credit of £1,125 to offset against that due to your tax relief on buy-to-let interest. In other words, your £0 of rental cashflow before tax will become -£1,406 negative after tax

So in cashflow terms this doesn’t look too clever for a higher rate tax payer does it?

Or does it?

Remember to factor in the capital growth, in our example we assumed £7,500.

OK, that’s not cashflow but it is only taxed at 18% if you are a basic rate tax payer at the point of sale or a maximum of 28% if you are a higher rate tax payer.

So let’s assume that you sell after just one year. I will ignore costs of sale in this example.

  • If you are a 20% tax payer you will have a cashflow of £0 after tax plus a capital gain of £7,500 taxed at 18% which equates to a total profit after tax of £6,150. As a percentage of your initial investment (i.e. your deposit of £37,500) this equates to a return of 16.4%
  • If you are a 40% tax payer you will have made negative cashflow after tax of £1,125 plus a capital gain of £7,500 taxed at 28% which equates to a total profit of £4,275. As a percentage of your initial investment (i.e. your deposit of £37,500) this equates to a return of 11.4%
  • If you are a 45% tax payer you will have made negative cashflow after tax of £1,406 after tax plus a capital gain of £7,500 taxed at 28% which equates to a total profit of £3,994. As a percentage of your initial investment (i.e. your deposit of £37,500) this equates to a return of 10.6%

Now whichever scenario fits you, that’s still a far better return that you will get from a deposit account.

So it it worth it or not? Only you can decide!

There are some other points to factor in though.

  1. Your mortgage balance will not increase with traditional interest only finance
  2. Your rent is likely to increase in line with demand, thus increasing your rental profits and your overall returns over the years
  3. 5% capital growth is not guaranteed, it could be more, it could be less.
  4. You may get more or less than a 5% gross rental yield. The general rule of thumb on this is that higher yielding properties have higher costs and lower capital growth. There are always exceptions to the rule though.
  5. We don’t know whether the government will tinker further. I haven’t factored in Selective Licensing costs either, and that could be applied in your area, even though it might not apply now.

Please discuss.



Comments

Chris Harris

10:57 AM, 14th July 2015
About 4 years ago

Reply to the comment left by "John Maynard" at "13/07/2015 - 21:21":

Multiple companies would probably not work as they would likely be treated as a group by HMRC and their turnover consdered as a whole.

Mike W

19:03 PM, 14th July 2015
About 4 years ago

Thank you Mark for providing a basic example, albeit in my view rather optimistic. Indeed this is a tax attack on higher rate tax payers, akin to that of the Polish communist government after WW2. It is fundamentally anti business and ought to worry any self employed business man. If the government can apply this mechanism on financing costs in property letting, will it extend to hotels and guest houses and 'corner shops'? This is a very dangerous move.

When I initially drew up my spreadsheet to not only do what you have presented for one year but to generate a forecast for 10-15 years, I assumed no capital growth whatsoever. For some areas of the country that zero or negative growth has applied - mid Wales being one example. I factored in my buying and selling costs in the spreadsheet and of course inflation. Building a spreadsheet allows you to vary the parameters.

The problem with assuming house price growth higher than basic inflation becomes obvious once you play with the spreadsheet. There comes a point when you cant buy the house or make it profitable. In other words there are limits to both house price growth (price/income ratios) and rent growth (rent/income ratios). The proof lies in seeing what has happened in central London. How many 'norma'l UK citizens live there?

Moreover at present we have very low interest rates. The BoE fired a warning shot this week. Start increasing interest rates in the spreadsheet and see what happens......

Doom and gloom? No realism.

The company route has a problem. Getting the money out of the company. The lack of tax free allowances. The changes in dividend tax requires a lot of shareholders.

Somehow I think the government does not want BTL professional investors.

Mark Alexander

19:13 PM, 14th July 2015
About 4 years ago

I suspect the government feels it has enough BTL investors but have gone a step too far and will kill off the existing ones if the tax reforms progress as proposed.

If I am right, the logical solution is only to apply the new tax system to new debt.
.

Linda Price

13:50 PM, 7th August 2015
About 4 years ago

Hi John, This is what we've been doing for a number of years, as I was fed up of all the hard work we were 'not' doing. My aim was to transfer one property a year to the company, but it is expensive and the banks will only lend on a repayment basis. We can now draw a little salary as well. We make sure we keep under the VAT threshold by getting the client (us) to purchase all materials, and then the Ltd company charges for doing the work.

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