Tackling the ‘terrible tax change’ on buy-to-let

Tackling the ‘terrible tax change’ on buy-to-let

Henry Emson

So serious is this adjustment by the Government that former Bank of England economist, David Miles, referred to it as ‘terrible’

According to Henry Emson, Business development manager at MMC Ventures, Landlords who directly own a mortgaged buy-to-let residential property are facing a seismic change to their financial position as they cease to be able to run the arbitrage between rental income and cheap debt.

Henry had this to say: "As of April 6th 2017 interest payments will gradually cease to be an allowable deduction against rental income, turning historically profitable portfolios into cash negative assets. So serious is this adjustment by the Government that former Bank of England economist, David Miles, referred to it as ‘terrible’.
 
So, what does this mean for historic property owners who have relied on real estate to provide both wealth and income?

i) As they sell out of the residential property asset class they will see a 28% Capital Gains Tax (CGT) levied – a significant impact on their net worth.

ii) They need to find a new means of wealth generation; no easy task at a time of such low interest rates.

One investment tool that suitably addresses this change in circumstance is EIS.  It allows for CGT deferral so as to keep investor net worth undiminished,  Income Tax relief to bring down the net cost of investment, and Share Loss Relief to reduce exposure to company failures.  In addition any capital gains are free of tax, and EIS shareholdings are exempt from inheritance tax after two years ownership - all assisting in the maintenance and creation of wealth.  For the right client with the right circumstances these advantages can all aggregate within one subscription.


EIS investment reliefs were created by the Government to encourage innovation in the UK and create jobs in the private sector.  EIS Growth Funds are focused on investing in qualifying companies with significant growth potential.  These companies have to be early stage and unlisted (with the exception of AIM) – so by default this is classified as an ‘illiquid and high risk’ asset class. While this statement holds true of the underlying companies themselves, the layer of expertise added by successful EIS fund managers and the downside protection provided by the tax reliefs creates a material advantage to the investor, offering a real opportunity for wealth generation.

Taking the case of a buy-to-let individual now investing in EIS, using only the gain realised from residential property sales, the below example shows how CGT deferral allows for future settlement of the tax liability using a combination of reliefs and portfolio profits.

Assuming the property sale creates a gain of £100,000, on deployment of the capital the investor receives £30,000 Income Tax Relief – enough on its own to settle his/her CGT liability which at 28% would be £28,000.

The example shows a portfolio performance of 2x multiple return providing a net exit, including settlement of the deferred CGT, of £231,450 on £100,000 invested.  This does not include any future benefit of IHT exemption at 40%.  Even if the portfolio performance was lacklustre and near flat, the argument would still be extremely compelling due to the tax reliefs where on investment the combination of Income Tax Relief and CGT deferral immediately provides a 58% tax advantage over investing in say FTSE 100 stocks.

That’s a huge hurdle against which to benchmark the expected performance of other asset classes.
Summary

No one would suggest EIS as an equally weighted alternative asset class to property. That said, in that first transition out of a buy-to-let portfolio the portion of sales revenue that is capital gain is highly unlikely to find a more attractive investment than EIS.

EIS should represent a small part of an individual’s overall portfolio, however returns can outperform much larger positions in other asset classes - which is a sensible way to think about EIS allocation - higher risk for higher rewards - with a substantial downside protection buffer provided by HMRC, and an added incentive for those coming out of buy-to-let property."

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Latest Comments

Oliver Conway
Oliver Conway 18 May 2017

Making a neat inventory is a good idea, but if the seller is not willing to provide it, can the buyer demand it?

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Bertrand
Bertrand 17 May 2017

First step to nationalisation of the private rented sector IMHO. Nanny state poking their noses into things yet again. I object, as a decent landlord, sometimes having to deal with some pretty awful tenants,...

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Izzy
Izzy 16 May 2017

This is such a great a post. I love the detail you've gone into. It's a very useful article for helping those who are looking at deciding which sector they would like to go into! When I first started investing...

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paul burnham
paul burnham 30 Apr 2017

Jeremy Corbyn's pledge that a Labour government would build 500,000 new council houses must electrify the general election campaign. Reliance on markets and the profit motive has brought huge housing-related...

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CommercialTrust
CommercialTrust 28 Apr 2017

Sadiq Khan?s announcement of an online database of landlords and letting agents who have been convicted of housing offences, appears on face value to be a variation of the already implemented Database

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warren
warren 26 Apr 2017

You're very welcome Mary! Glad you enjoyed them :)

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Mary Ward
Mary Ward 26 Apr 2017

Thank you for the wonderful ideas. First impressions can make or break a deal. It's sadly that many homeowners drop the kerb to create an off-street parking space.

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Tony Gimple
Tony Gimple 14 Apr 2017

I'm not at all surprised that so many landlords are still confused about what the tax changes really mean and how it will affect them. In particular, the blind rush to incorporation is leaving landlords...

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MH
MH 13 Apr 2017

You are right that the bank holidays are going to be spoiled in looking for the properties. But people who want to sell their property and looking for the better relocation, they can get benefits of this...

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bnellyb
bnellyb 08 Apr 2017

There will be an exodus of private landlords over the next 5 years as tax changes take effect, private landlords provide an important service to the rental market, why do housing associations and councils...

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Fred Cassman
Fred Cassman 07 Apr 2017

"Make it look like you are at home": often people forget this and share on facebook their location!

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jared townsend
jared townsend 05 Apr 2017

It'll be interesting to see how & if the Government's asset sale regarding mortgages helps

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