Is it time for landlords to sell up?

In an interview published on 27 November 2023, the governor of the Bank of England has poured cold water on the prospects of significant interest rate cuts in the near future, stating he recognised that higher interest rates:

‘have effects on mortgage costs, and they also have an effect on rental costs because they feed through…[but] I have pushed back of late against assumptions that we're talking about cutting interest rates or we will be cutting interest in anything like the foreseeable future because it's too soon to have that discussion.’

So, it seems landlords with buy-to-let mortgages are either looking down the barrel of higher interest rates or have already faced that firing line. For some, a difficult decision awaits. It may be that the only option left for them is to sell up a proportion, if not all, of their property portfolio.

The difficulties for landlords have been growing in recent years but the key issue for many unincorporated landlords is the restriction on income tax relief for mortgage interest paid. The restriction applies by effectively limiting the tax relief that can be obtained to the basic rate of income tax, currently 20%.  

A stated motive behind the restriction was to put landlords on more of a level playing field with other homeowners and individuals investing in other assets, who do not generally benefit from any similar tax relief. Given it was a significant change, landlords were given the best part of a two-year period to prepare for it and the restriction itself was phased in over another four-year period, from 2017 onwards. 

However, with historically low levels of interest rates until recently, many landlords may have failed to appreciate the full implications of the restriction. Indeed, it could already present a challenge to some landlords, who could be paying income tax on their rental income even if they are in reality making a commercial loss. With higher interest rates, that position may be becoming more desperate. 

With continuing interest rate uncertainty, some landlords have been looking at alternative options to mitigate the impact. That has often involved exploring a potential property business portfolio incorporation as companies are unaffected by the income tax restriction rules. However, this is not appropriate for all landlords, and for many may not be feasible. 

A key barrier to incorporating is the lack of certainty over the tax treatment of the incorporation itself. Such a process could potentially trigger a significant capital gains tax liability and there is no longer a facility to confirm the position in advance with HMRC. 

The practical challenges and uncertainty around incorporations have led some landlords to implement what HMRC considers to be an ineffective tax avoidance scheme. HMRC has recently confirmed that it has sent letters to a small number of landlords who have implemented this scheme. Based on information from Companies House, there could be several hundred taxpayers impacted. 

HMRC outlined that it is: 

‘targeting the promoters and controlling minds behind these schemes, disrupting the structures they have created by closing down options available to them and making it progressively harder for them to profit from promoting avoidance’.

This is unlikely to be the only form of property incorporation planning being examined by HMRC. Those who have implemented variations of this planning with similar steps may also face scrutiny from HMRC in the future.

If an incorporation is off the table, the brutal reality for some landlords may be that they have to sell some of their properties to pay down their debt. There are other reasons why this might be an appropriate time to do so. With a general election looming, it is not beyond the realms of possibility for there to be a hike in capital gains tax rates for those selling second properties in the future.   

If tax giveaways for landlords seem politically impossible, there is one low-cost tax change that could make a huge difference to them. The government could provide more definitive legislation confirming the basis on which landlords can benefit from a tax-efficient incorporation. Alternatively, a statutory service for landlords could be introduced to obtain advance confirmation that incorporation relief is available. That would not be a tax break, but it would provide certainty. Ultimately, it could save taxpayer funds and help deter landlords from running into the arms of promoters of tax avoidance schemes that HMRC considers don’t work.