Struggling buy-to-let owners have been hit by another blow, with the news that HM Revenue & Customs (HMRC) has launched 7,371 informal investigations into landlords suspected of failing to declare and pay tax.
Targeting tax evaders
The figures, which cover just the last four months, are part of HMRC's campaign to target buy-to-let landlords, which it suspects are widely failing to declare income and are consequently evading tax. Accountancy firm UHY Hacker Young, which obtained the statistics under a Freedom of Information Act enquiry, says it seems as if an expected clampdown has begun.
HMRC is now likely to contact people thought to be earning undeclared rental income. UHY Hacker Young says that these informal investigations can yield more useful information for HMRC than if it opened a formal investigation. The firm reports that HMRC has already contacted lettings agencies to obtain lists of landlords, which it is then matching against its records of taxpayers' declared income. HMRC will follow this up to obtain detailed information from property owners about their investment activity, repairs and other costs and rental income.
Buy-to-let landlords must also be wary of breaching stringent regulations on tenancy deposits. Since April 6 2007 landlords have been required to register all new deposits they receive with one of three Government-approved schemes. Failure to do this could lead to fines of three times the value of received deposits.
Confusion rules
UHY Hacker Young says that the targeting of buy-to-let landlords reflects, in part, the widespread confusion about their obligations and the resulting frequency of errors. Roy Maugham, tax partner at the firm, says: "While there is no legal requirement to comply with these interventions, taxpayers who are contacted should take it seriously. Those who think they may owe tax on their rental income should make an early disclosure as part of a negotiated settlement in order to minimise the cost of penalties they incur.
"Landlords need to be aware that repairs and improvements to buy-to-let properties are taxed differently. If expenditure permanently enhances the value of a property, such as an extension, it cannot be offset against rental income. Repairs are a tax deductible cost. Also, buy-to-let landlords can only offset the interest component of their mortgage against rental income. Investors often mistakenly assume that their monthly installments can be offset against tax, but that will normally include capital repayments which are not allowed.
"Investors may be making a profit from selling their property, even if it is simply to repay their borrowings. Unpaid capital gains tax on sales of buy-to-let investments could be huge, so landlords need to make sure they have taken it into full account. Some landlords may not realise that they need to declare any interest gained from tenant's deposits and even pay tax thereon if they are a higher rate tax payer. Landlords need to get their house in order and be very careful about checking the accuracy of their tax payments or they may be heavily penalised."
Difficult times for buy-to-let
The tax clampdown on buy-to-let landlords comes at a very difficult time for the sector. Many homeowners who have been unable to sell properties have instead become 'accidental landlords', forcing down average rents as a result. According to a survey by the Royal Institution of Chartered Surveyors, more than half of its members in London observed falling residential rents in the city.
Meanwhile, buy-to-let borrowers face increasing difficulty in obtaining and servicing their mortgages. Richard Pym, who became chief executive of the Bradford & Bingley bank just before it was nationalised, told the House of Commons Treasury Select Committee: "Essentially the buy-to-let market in the way that we would have known it a year ago is now closed. Most of the lenders who were active have now withdrawn all their products."
A study just published by credit ratings agency Standards and Poor's reveals that about one in five buy-to-let mortgages taken out in 2006 and 2007 is now in arrears - a much higher rate than that for mortgages taken out by owner-occupiers. Potential negative equity rates are also much higher amongst small scale landlords than with owner-occupiers.