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Tax on buy-to-let property and rental income

Tax on buy-to-let property and rental income

Category: Buy To Let

Updated: 04/08/2017
First Published: 11/04/2017

For many, property has a unique physical appeal that shares and investment funds just can't match. But the Government has been clamping down on this form of investment as it looks to control the housing market. The tax position of buy-to-let investing is therefore changing.

Buy-to-let (BTL) is subject to several taxes, regardless of whether you own a single property or 100 properties.

There are four taxes that your investment in a BTL property will possibly incur:

Stamp Duty

Income Tax

Capital Gains Tax

Inheritance Tax

Forming a limited company

Stamp duty on buy-to-let

Stamp duty is a tax you pay when you buy any property in the UK. It's set in tiers, depending on the price of the property. From April 2016 Stamp Duty rates have increased by 3% at each tier to the following:

Stamp Duty Rates

3%

On the first £0 - £125,000

5%

On the portion from £125,001 - £250,000

8%

On the portion from £250,001 - £925,000

13%

On the portion from £925,001 - £1,500,000

15%

Everything over £1,500,000

For example:

If you were to buy a property for £300,000 you'd pay the following stamp duty:

  • On the first £125,000 - £3,750
  • On the amount from £125,001 to £250,000 - £6,249.95
  • On the next £50,000 - £4,000

This comes to a total of £13,999.95.

Stamp duty is a one-off tax. That means that if you decide to rent out your home (because you can't sell it or you're moving in with a partner), you wouldn't have to pay it again as a buy-to-let landlord on the same property.

Income tax on buy-to-let

The income you receive as rent is taxable. You need to declare any rent you receive as part of your Self Assessment tax return. The tax on your income is then charged in accordance with your income tax banding (20% for basic rate taxpayers, 40% for higher rate, and 45% for additional rate).

However, you can minimise the tax you have to pay by deducting certain "allowable expenses" from your taxable rental income. Allowable expenses include:

  1. Rents, rates, insurance, ground rents etc.
  2. Property repairs and maintenance.
  3. Interest on buy-to-let mortgages and other finance charges.
  4. Legal, management and other professional fees such as letting agency.
  5. Other property expenses including buildings insurance premiums.

The Summer Budget in 2015 introduced changes to the amount of tax relief that is available for interest on buy-to-let mortgages. Landlords paying higher (40%) or additional (45%) rate tax could claim tax relief at their highest rate, but the Budget changes mean that tax relief will only be reclaimed at the basic rate (20%), whatever rate of tax the landlord pays.

So, if you're a landlord who only pays basic rate tax, this change won't affect you, but if you pay at 40% or 45%, you'll be losing out. The available tax relief will reduce over the subsequent three tax years and will be fully in place by 2020/2021.

Another change from April 2016 was the removal of the "wear and tear" allowance. Previously, a landlord could claim 10% of their rent as tax relief for wear and tear, but this is no longer the case. Instead, the allowance has been replaced by a system that only allows landlords to claim tax relief when they replace furnishings.

If you're in any way unsure, an accountant can help you make the most of your allowable deductions so that you don't pay more tax than you have to.

One peculiar thing about rental income is that it doesn't qualify as income for pensions purposes. So if all your income is from renting property, you would not benefit from tax relief on your pension contributions as you can with most income. Income from a furnished holiday let, however, does qualify!

HM Revenue and Customs requires you to keep a record of your income and expenses as a buy-to-let landlord for at least six years.

Capital gains tax on buy-to-let

You do need to pay capital gains on your buy to let propert, but only if you've made a profit. Capital gains tax is payable when you sell a buy-to-let property at a profit compared to when you bought it. It isn't payable if you make a loss.

You get an annual tax-free allowance of capital gains that you can make each tax year before capital gains tax is charged.

If you've sold a buy-to-let property, you'll need to declare this on your tax return. Capital gains tax is charged at 18% or 28% of the profit (depending on the taxable income and total capital gains you've made over the year). Again, a furnished holiday let may attract a lower 10% rate of CGT due to 'Entrepreneurs Relief', which applies to selling certain businesses.

If you've made a loss on a buy-to-let property sold in a previous year, you may be able to use this loss to reduce your capital gains bill. Similarly, you are able to deduct some expenses you've incurred in buying, selling or improving the property:

  1. Solicitor's fees.
  2. Estate agent's fees.
  3. Costs involved in advertising the property for sale.
  4. Costs incurred in increasing the property's value (improvements, but not maintenance or general upkeep costs).
  5. Stamp duty.

Inheritance tax on buy-to-let

You may need to pay inheritance tax on buy to let properties. If an individual's estate exceeds £325,000 (or up to £650,000 for married couples or civil partners), inheritance tax is charged at 40% on everything above this threshold (other than on estates passing to the spouse or civil partner, which are free of inheritance tax).

This isn't nice to think about, but very important to plan for. Your buy-to-let properties (or property) form part of your estate for inheritance tax purposes.

You may qualify for Business Relief if your buy-to-let portfolio was run as a business. This will depend on a number of factors.

A good accountant may be able to help you reduce your exposure to inheritance tax.

Can I form a limited company and pay less tax on my buy-to-let property?

It's possible, yes. However, there are a lot of factors involved in this decision.

Limited companies are except from the mortgage relief restriction that came into force in April 2017. This is because any interest made from a business property is classified as a business expense, and is therefore fully deductible against income.

Company owners will know that you must pay corporation tax at a fixed rate regardless of the size of your profits. This rate is currently 20% (reducing to 16% in 2020). Compare this to the 40% or 45% that buy-to-let landlords must pay on their property earnings, it is an attractive proposition.

It's not quite that simple though. Be aware though that you as an individual may need to pay tax to get access to the money earned by your limited company. For example, if you access your earnings as a dividend, only the first £5,000 of that is tax free. Any dividends in excess of £5,000 will be charged at either 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers or 38.1% for higher rate tax payers. And this is after the corporation tax at 20%.

You could choose to take the earnings as a salary. If you do, be aware that your limited company would have to operate PAYE and include national insurance contributions on any salary paid. In most cases, this will work out more expensive than taking the money as dividends.

Always seek advice from a specialist before considering forming a buy to let limited company. Our expert mortgage advisors can help guide you through this process

What next?

Compare the best buy-to-let mortgages

Speak to a specialist buy-to-let mortgage adviser

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

 

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