Landlords will no longer have automatic entitlement to a 10% tax break for wear and tear of their properties.
The important change came largely unnoticed after yesterday’s Budget headline announcement that mortgage interest relief for private landlords is to be restricted to the basic rate of income tax.
While the Chancellor’s shake up of tax relief will effectively double the cost of borrowing for those paying the highest rate of tax, landlords have almost six years to prepare for the change.
The measure will also have come as good news to those who feared the relief would be abolished altogether.
As it is, the tax relief will be halved for those paying the highest tax rates.
Under the withdrawal of interest relief, in 2017-18 landlords will only be able to apply the existing relief rules to 75% of their finance costs with the remaining 25% using the basic rate reduction. The following three years will see the proportion change to 50:50, and then 25:75, before the basic rate applies in full from 2020-21.
But in the meaningful small print of the Budget, it has emerged that landlords will no longer automatically be able to deduct 10% as a tax break for wear and tear as from next April.
Instead, they will only be able to deduct from their tax bill the costs they actually incur.
The two measures mean that the Government is indeed cutting back on tax breaks for private landlords, who argue that they should not be treated differently from other businesses, but whose tax regime arguably sits badly with home owners.
The small print does not say how the new wear and tear regime will work but says: “The Government will also reform how landlords of residential property can account for the costs they incur in improving and maintaining rental property.
“Currently, landlords of furnished properties can deduct 10% of their rent from their profit to account for wear and tear, irrespective of their expenditure.
“This means landlords can reduce their tax liability even when they have not improved the property. From April 2016, the Government will replace this allowance with a new system that enables all landlords of residential property to only deduct costs they actually incur.”
ARLA managing director David Cox said of the twin measures: “In a bid to limit the growth in buy-to-let properties, the Chancellor has announced plans to reduce the amount of tax relief investors can claim on mortgage interest payments. At a time when the supply of rental property is already struggling to meet demand, it is dangerous to try and reduce growth in the rental market.
“The Chancellor has also replaced the wear and tear costs with a new system that means landlords can only deduct the exact amount that they will incur.
“However, the unintended consequence of this, and the reduction in income tax is that landlords will seek to recoup their costs by hiking up rents. As a result, tenants will have to save for longer to be able to afford a deposit for a house, as more of their income will be eaten up by rent.
“This creates a vicious circle where tenants are renting for longer because the hope of owning a home becomes less achievable.
“The Government needs to think about the market more holistically and while the rental market remains such an important tenure, we need to find the right balance between landlord taxation and tenant aspiration.”
Chancellor George Osborne said: “Buy-to-let landlords have a huge advantage in the market as they can offset their mortgage interest payments against their income, whereas home buyers cannot.
“And the better off the landlord, the more tax relief they get.
“For the wealthiest, for every £1 of mortgage interest cost they incur, they get 45p back from the taxpayer.”
Osborne’s other major measures that could affect the housing market include raising the Inheritance Tax level on people’s homes, and abolishing permanent “non dom” status – effectively a death knell for offshore property companies.
The upping of the Inheritance Tax level could encourage older people to downsize, said Nick Leeming, chairman of Jackson-Stops & Staff.
The abolition of permanent non-dom status means that people resident in this country but who claim non-dom status enjoy significant tax benefits.
Leeming said: “The stricter rules being applied to non doms, while having some merit, will inevitably further dampen demand from international buyers in central London where the market for higher valued properties has already slowed sharply following last year’s changes in stamp duty.”
The phasing out of higher-rate tax relief on mortgage interest for private landlords has come in for most criticism.
Gráinne Gilmore, head of UK residential research at Knight Frank, said: “This is a significant change in tax status for those with a rental portfolio, although the measured rate of introduction between 2017 and 2020 will help landlords plan their approach.
“Those planning to purchase a buy-to-let property will have to factor these new rules into their calculations, and this could affect the offers they are willing to make.
“If the relatively low yield environment seen today, especially in the south of England, is still evident when these changes start to come into force, there could be upward pressure on rents.
“The need for rental accommodation is strong, and we expect this trend to continue, especially in city centre markets around the UK.”
Glynis Frew, managing director of Hunters, said: “Despite a phased approach, we were disappointed to hear of the reduction in tax breaks for buy-to-let investors as this will discourage new landlords from entering the sector and will result in a lack of stock.
“This will inevitably lead to higher rents, as at the end of the day landlords are business people and will need to compensate for this.”
Ed Heaton, of Heaton & Partners, said: “The changes will particularly hit those owning properties in prime central London where the sums involved are very high and the yields extremely low.
“Notwithstanding this, if one accepts the Bank of England’s arguments, then the proposed changes are probably a proportional response to the issue.
“It might even help release a little more prime stock in central London to the market in the next year or so, although this might be wishful thinking.”