With dealing with inflation now the number one priority for the Bank of England Monetary Policy committee, we have seen gradual and continuingly rising interest rates since the start of the year. Whilst this may be good news for savers, for borrowers not so much.
Those of us old enough to remember Black Wednesday in 1992 will recall interest rates increasing from 10% to 12% overnight. The big difference between 1992 and now however is that the size of the average homeowners’ borrowing is much higher due to house price growth over the intervening decades. It was painful for new homeowners then, but how much more so now!
Buy to let landlords also have been hit particularly hard. Conventional wisdom had it that the way you built up a property portfolio was via the OPM method, or as it’s better known, Other People’s Money. The other people in question are of course the banks and building societies. The underlying idea is to maximise the leverage capacity of your equity to maximise the size of your property portfolio. For as long as interest rates remain benign, or if you have a fixed rate mortgage, you don’t have a problem. The problem for all borrowers does arise of course once interest rates start climbing and when your fixed rate term comes to an end. Having to write blank cheques to your bank effectively is a nasty state of affairs.
Buy to let landlords have also been hit hard by the progressive removal since 2017 of tax relief on their buy to let mortgage. Because of this even putting up tenants’ rents is only of limited help, as you are at the same time increasing your tax liability.
To make the storm perfect, the rise in interest rates means that if you decide you want to bail out and sell some or all of your investment properties, you will find that interest rate increases will have put a dampener on property values. Prices have dropped by 10% in some areas over the past twelve months, and this trend is likely to be made worse by ongoing rate rises. So if you do want to sell, you are likely to see a drop in value compared to what property was worth not so long ago.
So far, not so good!
There is however a solution that may be viable. This involves the transfer of your property portfolio into a company structure. The advantage of doing this in the first instance is that if your net profits don’t exceed £50,000, the tax rate on them will be 19%. In this scenario you can in fact offset your finance cost against rental profits, as was the case for everyone before 2017. This compares very favourably with you if you are a private landlord and an additional rate taxpayer, paying 45% tax on the gross profit. The only offset for the mortgage finance cost is only at basic rate, i.e. 20%. In addition the costs of running the property company can be deducted from the rental profits. This means that legitimate business expenses can also be deducted from the rental profits.
It’s worth noting however that if you have a mortgage on your investment properties, your lender will need to agree to you transferring them into a company set-up. This may in turn have an impact on your mortgage interest rate. You would also need to look into the capital gains tax and stamp duty implications. In fact there are many areas that you would need to investigate before deciding to embark on this route.
Having provided you with the above health warning, it follows that professional advice is a must when considering this restructuring exercise. A competent property tax adviser however may well find ways of dealing with the niggly points I’ve highlighted.
To warrant more detailed exploration, you would need to have an investment property portfolio worth more than £1,000,000.
Having suggested there may be a tax structure that remedies the situation, it is certainly worth doing a calculation to see whether selling one or more properties, even at a loss, might be the better route to follow. You would need to consider not only the amount of mortgage interest that would be saved but also the decrease in your tax liability on the rental income. Selling at a lower value may in fact still be the best long-term solution. It would certainly be a simpler one!
I’m aware that this article is going to raise more queries than it answers, but given the space limitations and also the risk of boring you with overly technical content, I thought it best to paint my canvas with the broadest of brushstrokes. I would however suggest that, if you think that this type of planning may indeed be beneficial, do feel free to get in touch and run the details by me. I’ll do my best to help.
Joe Coten is a member of the Personal Finance Society. He may be reached on 0207 588 9626.
joe.coten@elem-inv.com
www.elementaryinvestments.co.uk
