Does Buy-to-Let stack up?
Whilst the Scottish Government has announced a ‘commitment to an effective system of national rent controls and measures to strengthen tenants’ rights’, we don’t yet know what those controls or new rights will be. In their agreement with the Scottish Green Party, the stated position is to make ‘housing in the rented sector … more affordable and more secure.’
This announcement is the latest of a number of regulatory and tax changes affecting the buy-to-let sector in recent years and its attractiveness as an investment.
Since 2015, there have been a number of changes to the taxation of rental income as well as property purchase and sale. These have had a profound impact on the economics of being a buy-to-let investor.
It seems that the sector is being taxed on the way in on purchase, during the lifetime of the rental and on the way out on disposal.
The current taxation regime for buy-to-let properties
In 2016 the Scottish Government introduced the Additional Dwelling Supplement (ADS). This means that in addition to any Land & Buildings Transaction Tax (formerly called ‘Stamp Duty’) you would normally pay for a residential property, the ADS will apply if you already own a residential property. The ADS also applies to organisations who buy residential property so if you set up a company to carry out this type of investment, you will still have to pay the ADS if you buy residential property as part of your investment portfolio. This means that if you buy a property for, say, £180,000 (around the average price of property in Scotland) the ADS, which is charged at 4%, would be £7,200. This is in addition to the £700 of Land & Buildings Transaction Tax of £700 you would pay for a property at that price. This means on the way in you are faced with a tax burden of £7,900.
During the rental life of the property, if you have taken out a buy-to-let mortgage, the tax relief on the interest payments has changed. Up until 2015, if you were a higher rate taxpayer, you could claim tax relief at the tax rate you paid on the interest you paid on your buy-to-let mortgage. That has now changed and tax relief is limited to the basic rate of tax of 20%. This might be acceptable if you are a basic rate taxpayer, but most landlord investors are higher rate taxpayers and, as such, have lost a previously existing interest relief benefit.
One of the key attractions of buy-to-let property is the capital growth in the value of the property over time. Many landlords view the rental income as simply a means to service the buy-to-let mortgage with the final aim of benefiting from the capital growth in the value of the property. However, landlords need to remember that capital gains tax will be payable on the increase in the value of the property over £12.300. On residential property the Capital Gains Tax rate is 18% if you are a basic rate taxpayer moving up to 28% if you are a higher rate taxpayer.
Regulation of private tenancies
In addition to the taxes to be paid when purchasing, operating and selling a buy-to-let property, regulation in the sector has been growing.
Rental properties must have built-in smoke alarms and carbon monoxide detectors. Landlords now have to provide an Energy Performance Certificate (EPC), safety certificates for electrical items, carry out an annual gas installation safety inspection, a legionella risk assessment and, if the property is being let furnished, only fire resistant furnishings. You even have to supply a set of step-ladders with a certain number of treads.
Not only does regulation apply to the property, it also applies to the tenancy itself. The Private Housing (Tenancies) (Scotland) Act 2016 introduced new rights that tenants enjoy and overhauled the previous Short Assured Tenancy regulation. The biggest change introduced by this legislation was to provide that the tenant has a right to stay in the property indefinitely. There are no longer any minimum or maximum rental terms.
The legislation also governs when and how you can apply an increase in the rent and limits the reasons for asking the tenant to leave. Those reasons are if you are selling the property, plan extensive renovations or if the tenant fails to pay the rent.
The main thrust of this legislation and the regulation now applying to private rented accommodation is to ensure the property is maintained in good condition and to provide tenants with greater security of tenure than they have previously enjoyed.
What does this mean for the future of buy-to-let properties
We don’t believe that the Scottish Government is finished with its reforms in this sector but don’t yet know what changes are yet to be introduced. We consider that any future change will be in the region of rent controls, additional tenants’ rights and property maintenance and repair obligations.
Despite the changes in the tax regime and increased regulation of the sector, a buy-to-let property remains a very popular investment. It can provide a return for the owner that would outstrip the return on the capital lodged in a bank account where current interest rates are historically low. In addition, owning and renting out property tends to be a low-risk investment with continuing capital growth as property values generally rise over the years. It is not a “get rich quick” investment and it takes diligent management of the finances, the property and the tenants’ requirements. If you manage all three, there is no doubt that a buy-to-let property will provide both a regular income and capital growth over time.
If you would like to discuss entering the buy-to-let market or purchasing or selling a residential property, please get in touch.