How to be a property investor: Understanding property taxes
Stamp duty is a one-off tax that you pay when you buy a property in the UK. It's set in tiers depending on the price of the property.
Since 1 April 2016 landlords and investors have paid a 3% stamp duty surcharge when they purchased new properties.
“Buying a new investment property is now potentially much more expensive as a result of the additional stamp duty charge, and some amateur landlords will find it harder to make the sums add up,” says Christian Faes, co-founder and CEO of LendInvest, “For many small landlords, expanding the size of their portfolio will be out of the question.”
- Read more about how to deal with stamp duty.
Landlords need to pay income tax on any profit that they make from renting out a property. The profit is the money left once they’ve added up your rental income and deducted any allowable expenses.
Changes to income tax for landlords will start to take effect in April 2017. Currently landlords can claim tax relief on their mortgage interest payments at their marginal rate of tax, so either 20%, 40% or 45%. But this tax relief will eventually be reduced to the basic rate of 20%. Read more about the new taxes on landlords.
The move will see landlords who pay the higher rate of tax make less profit or even a loss.
If you make a loss on your buy-to-let property, you can carry it forward and set it off against rental profits in future tax years, but you cannot set it off against other income. Read more about how to deal with tax on rental income.
“One option for landlords will be to simply raise rents, but they will have to be careful; raising them too much will dent demand for the property, and may end up costing them even more as a result of void periods,” says Mr Faes. “Other landlords may look to absorb some or all of this additional cost, but obviously this will damage, and in some cases, essentially wipe out their profit margins."
Council tax is levied by the local authority per property on a banding basis. In the majority of cases liability for council tax lies with the tenant. However, landlords are liable for council tax during void periods at their properties.
There are discounts available. However, these will depend on whether the property is furnished or unfurnished and the level of discount set by the local authority.
Capital gains tax
Capital gains tax is payable when you sell a buy-to-let property at a profit from when you bought it. Everyone has an annual tax-free capital gains allowance of £11,100 (for 2016/17).
Landlords can benefit from tax relief if the property has been their main home at some time (called private residence relief or PRR), plus the last 18 months of ownership. Landlords can also reduce the capital gains tax due by claiming letting relief.
Currently, sellers work out the CGT after the end of the tax year as part of their tax return. However, from 2019 CGT from the sale of property will be payable to HMRC within 30 days of the sale.
If your estate exceeds £325,000 (£650,000 for married couples or civil partners), inheritance tax is charged at 40% on everything above this threshold.
Save tax by incorporating
Accountants PwC says if a private landlord transfers a property into a company structure, known as incorporating a business, the total tax rate is greatly reduced.
The graph below shows the total tax rate for private landlords compared to businesses after the tax relief changes have taken effect in 2020.
- The property is worth £100,000
- The landlord is in a higher tax bracket
- The mortgage is at 85% loan-to-value
At a mortgage interest rate of 5% the tax levy would be 106% for a private landlord but just 49.2% for a business.
Don't miss the first articles in this series:
- Our national love affair with property
- A history of property prices
- Property versus pensions
- Buy to let: Buying a property
- Buy to let: Letting it out
- Buy to let: new taxes for landlords
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.