Wednesday, 2 September 2015

Landlords and the restriction for mortgage interest relief

In response to signing the petition to the Government concerning the decision to deny higher rate tax relief on mortgage interest paid by landlords, I and every other signatory have received the following email. I will let you read it and comment further down.

Government response

“Hi Jon Stow,

The Government has responded to the petition you signed – “Reverse the planned tax relief restriction on ‘individual’ landlords”.

Government responded:

The Government is committed to a fair tax system so is restricting relief on landlord property finance costs to the basic rate of tax, reducing the generosity for wealthier landlords.
The Government is committed to a fair tax system so is restricting tax relief landlords can claim on property finance costs to the basic rate of income tax.

Landlords are currently able to offset their mortgage interest and other finance costs against their property income, reducing their tax liability. This relief is not available for ordinary homebuyers and not available to those investing in other assets such as shares. Currently the landlords with the largest incomes benefit the most, receiving relief at their marginal tax rates of 40% or 45%.

By restricting finance cost relief available to the basic rate of income tax (20%) all finance costs incurred by individual landlords will be treated the same by the tax system. This recognises the benefits to the economy that investment in property can bring but ensures the landlords with the largest incomes will no longer benefit from higher rates of tax relief.

By unifying the treatment of finance costs for all individual landlords, the Government is reducing the distortion between property investment and investment in other assets, and reducing the advantage landlords may have in the property market over ordinary homebuyers.

Less than 1 in 5 (18%) of individual landlords are expected to pay more tax as a result of this measure. Taking account of the other measures from the Summer Budget, the Office of Budget Responsibility (OBR) have not adjusted their forecast for house prices. The OBR expect the impact on the housing market will be small. Furthermore, this change is being introduced gradually from April 2017 over 4 years. This will give landlords time to plan for and adjust to these changes.”

The reality

Not every landlord will be affected by the change, but a substantial number will be. It will be especially difficult for long-term landlords with multiple properties and with a higher gearing in terms of mortgages. As property inflation has progressed, many will have re-mortgaged in order to buy further properties. In many cases, such a model will not be viable, because there will be no profit left.

I can sense that some will say sarcastically that their heart bleeds for the poor landlord who no longer receives net income from their properties. Yet the landlords affected will be in a trap. How can they divest themselves of their portfolio in short order, and in this context, two, three or four years is not long? If they do sell up of course the Government will reap a reward in terms of large amounts of capital gains tax, but it is hard to see substantial benefit to the housing market in terms of more property available to first-time buyers. Purely in terms of numbers it is unfair and will put some landlords out of business.

Of course if the property portfolio is held through a company, mortgage interest relief will not be restricted. Yet comparatively few portfolios are overall, especially with the higher mortgage gearing, and that is for commercial reasons. Mortgage lenders do not like lending to companies because they have less security. In the past I have dealt with a client who had property portfolios worth in excess of £3M with borrowing of nearly £2.5M. He would not be able to carry on.

You might have noted that I mentioned putting landlords “out of business”. The response from HM Government talks about property investment, but HMRC does see rental activities as a business in some contexts. In a business, one expects to deduct in full all one's revenue costs. Is there a slippery slope which will bring more commercial activities to lose full relief for finance costs?

Property “investment” is not like holding a portfolio of shares or multiple ISAs or money on deposit. There is a risk as with stock market investments, but anyone who has been a landlord will tell you that there is a lot more involvement as a landlord, even if you use a letting agent. It can be very hands-on.

Suppose the tenant causes a fire or a flood and you have to deal with the insurance company, attend the site on multiple occasions to see the insurance assessor, get builders' estimates, supervise the builders, and get the letting up and running again. It can take many months, be pretty full-time, and very stressful. Believe me, I have been there, fire and flood. It definitely feels like running a business. The time commitment is often very substantial.

The Government and HMRC on their behalf are being disingenuous. It suits them to make a tax-grab from people whose effectively full-time work is from their letting business, and who are often providing a real service to local authorities in dealing with their displaced people requiring housing.

It would not be a “fair tax system” for those whose property businesses will be destroyed.

I believe the new rules will be a costly mistake; costly for the landlords, but also for those who need a roof over their heads but will never be able to afford to buy.

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