What are the tax implications for buy-to-let landlords?
For any investor who dived into buy to let in 1996 when the market was first established, the rewards will have been ample. From capital appreciation alone, they would now be sitting pretty. The average house price nationally back then was £53,394, according to Nationwide. Today, it's £167,294, meaning a 213.3% increase.
Provided property prices continue to increase and the income from renting out the property covers all of your costs in owning and maintaining it, buy-to-let can be a great investment.
But the problem with any investment is that it means you have to pay tax and many buy-to-let investors - especially the majority of landlords, who have just one property - do not seek specialist property tax advice. In a recent survey of landlords with portfolios of at least 11 properties, 89% of them admitted to being clueless when it comes to tax.
But there's only so long you can get away with being in the dark. HMRC is looking closely at landlords who have sold properties and appear to have paid no capital gains tax (CGT). The consequence could be fines or criminal prosecution.
At property clinics she has run throughout the UK, Kate Faulkner, managing director of Propertychecklists.co.uk, has come across landlords who have been oblivious to the need to pay income tax for a decade. She has met buy-to-let investors who sold without knowing they had to pay CGT and others who are signing over the ownership of properties to their children without the correct legal or financial paperwork, potentially leaving their family with huge problems when they inherit.
Taxes that will affect your buy-to-let
You will need to pay this on your rental income, minus costs. The costs you can offset against tax are numerous, including mortgage interest, lettings agents' and accountants' fees, insurance, utility bills, council tax, cleaning, maintenance and repairs (but not improvements; building an extension will enhance the value of your property, but you can't claim it as a daily expense in the running of that property).
The key to keeping on top of your tax is to keep all receipts in a separate file and make sure everything is up to date. Poor admin is one of the biggest downfalls of buy-to-let landlords. Also remember, when calculating your rental income for your tax return, you need to exclude the deposit you receive from each tenant.
If two or more of you own a property, bear in mind you can only claim income to reflect the ownership of the property. So if you each own 50%, you have to declare 50% of the income.
Capital gains tax
This is the tax paid on the net gain in the property's value, minus costs and any reliefs. To work out how much CGT you need to pay, take the gain and then deduct your buying and selling costs (including Stamp Duty Land Tax, solicitors' and estate agents' fees), any capital investment on improving the property (such as new windows or a new boiler, but not normal maintenance costs such as repairs or decorating) and then pay tax on what is left (18% for the basic-rate tax band and 28% for any gains above this band).
If you and your partner have invested in a property together, you can use both of your capital gains tax-free allowances - currently £10,900 per person. When selling a property in which you live, you are entitled to Private Residential Relief and Lettings Relief. If it's your only home or main residence, you won't be liable for CGT. If you sell part of your garden without selling your house, you may also qualify for this relief. And the final three years before you sell it, even if you weren't living in the house, also qualify for relief.
Reasons for not getting the relief are if your plot (including the house) is more than 5,000 square metres - the size of a football pitch; if you've let out all or part of your home; if you bought it purely to make a quick sale or if you buy a property for a relative to live in and don't live in it yourself.
This tax applies when passing on your property and the rules are complicated, so you must seek professional advice. Appealing as the prospect may be of inheriting or giving a house, property is one of the least tax-efficient assets to pass on as there is little tax relief. The estate of someone who owns two or more properties will quickly exceed the current inheritance tax threshold of £325,000.
When buying a property with someone else, you will be asked whether you want to invest as Tenants in Common or Joint Tenants. Always pick the former when investing. Joint Tenants is usually more relevant to couples who buy a home together that they will live in and pass on to the other in the event of their death. Tenants in Common is the best option for co-investors as it allows them to pass their share into a trust for beneficiaries. Otherwise, the tax implications if you get it wrong can be costly and confusing.
Three tricks to getting your property tax right
1. Don't listen to your friends, family or other investors. For expert advice, you will need a property tax specialist. Be clear on your current income and assets. Despite what many investors believe, a buy-to-let investment doesn't work independently of the rest of your life. You will be taxed based on what your total earnings and assets are, including your buy-to-let. So if your rental income from your buy-to-let takes you from a 20% to a 40% taxpayer, then your investment property could end up costing you money.
2. Know what you can claim for. Some investors and many accountants don't even know all of the relief you can get on your buy-to-let property. But you need to know from an income and a capital gains perspective.
3. Be clear about your objectives. Do you want to secure capital growth from buy-to-let or extra income, perhaps to boost your pension? An understanding of this can help ensure your property portfolio is set up in the best way from a tax and legal perspective.
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.