Yes, unfortunately, you do pay tax on a buy to let property. You are liable for tax when you buy, sell (or die in whilst still in ownership of the property) and on your income in between.
This article covers the basics but we strongly recommend that you take advice from a tax expert – we work closely with several consultants who specialise in this field and with whom we can jointly help guide you through the tax minefield that this has become.
Types of tax
When buying a buy to let property a variable amount of Stamp Duty will fall due.
The amount of tax depends on the purchase price paid and was increased by the imposition of a 3% surcharge from April 2016.
The current rates of stamp duty on buy to let properties are as follows: –
3% tax on the first £125,000
5% on the portion up to £250,000
8% on the portion up to £925,000
13% on the portion up to £1.5 million
15% on any amount over £1.5 million
As mentioned above, as from April 2016 anyone buying a second property that isn’t their main residence will pay the additional 3% tax surcharge.
In addition to properties bought as a buy to let investment this additional tax will also apply to a property bought as a holiday home or for holiday let and a property bought for children if the parents leave their name on the title deeds.
Although payment of stamp duty can be deferred for up to 30 days from completion of the purchase it is usually paid by your solicitor on completion.
If you sell the property for more than you paid for it (after deducting costs such as stamp duty and legal/estate agent fees) you will be liable for Capital Gains Tax on the profit.
However, as an individual you have an annual allowance (in 2016/17 this allowance is £11,100) which can be set against any gain. If the gain is greater than the amount of allowance the tax paid will be equal to either 18% or 28% of the profit depending on the amount of income and capital that you have.
How can I reduce the amount of Capital Gains Tax I pay?
Although there is no legal way of avoiding Capital Gains Tax there are various legitimate ways to reduce the amount of tax payable – for example any loss made on the sale of a buy to let property in previous years can be taken into account when assessing the amount of profit you make on selling your latest property. All fees such as solicitors, estate agents, costs of advertising the property for sale plus stamp duty and any expenditure on ‘capital’ items can be deducted from the gross profit and will not count towards the amount of Capital Gains Tax you pay. In addition there are also certain tax reliefs available. For example, if the property was previously your main residence, the gain may be reduced. You are required to declare an capital gains on your Self-Assessment tax return.
Currently, the tax is payable by the 31st January in the year after the tax year in which the property was sold. (e.g. if a property was sold on 4th June 2016 it is in the tax year to 5th April 2017 so the tax is payable by 31st January 2018.) However, from April 2019, any tax payable on the profit of the sale of the property will fall due for payment within 30 days of the date that the property is sold.
On property income
The income you receive as rent is taxable and 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). Again although there is no legal way to avoid being assessed for tax there are ways in which you can minimise the amount of tax that you have to pay.
Certain ‘allowable expenses’ can legally be deducted from your taxable rental income, including:
Interest on buy to let mortgages and other finance charges (but see below)
Council tax, insurance, ground rents etc.
Property repairs and maintenance – although large improvements such as extensions etc. will not be income tax deductible. They will be added to the cost of the property when it is sold and be deductible against any capital gain.
Legal, management and other professional fees such as letting agency fees.
Other property expenses including buildings insurance premiums
The amount of tax relief that is available for interest on buy to let mortgages is reduced from April 2017. Prior to April 2017, tax is payable on your net rental income after deducting allowable expenses including mortgage interest. This means that landlords paying higher (40%) or additional (45%) rate tax can claim tax relief at their highest rate. However, from April 2020 tax relief can only be reclaimed at the basic rate (20%), whatever rate of tax the landlord pays.
The rules are being phased in over 4 years commencing April 2017 and the amount of reduction in mortgage interest allowance in each of the interim years is as follows –
25% in 2017-18,
50% in 2018-19,
75% in 2019-20,
100% in 2020 and beyond
The tax impact of the new interest deduction rules will be a significant increase to the tax bill for higher rate taxpayers.
Even some basic tax rate payers will find themselves worse off. Although it doesn’t appear that a basic rate tax payer will pay any more tax under the new rules (because the rate at which they can claim relief against mortgage payment remains at 20%), there is a sting in the tail because the new rules also change the way income is calculated.
The following example will help clarify the change: –
Assume a landlord has £35,000 of employment income plus an annual rental income of £15,000 and mortgage interest of £10,800.
Under the old rules the net profit of £4,200 and £35,000 employment income would all be taxed at the lower rate of 20%.
Under the new rules, from 2020, the income from rental of £15,000 and employment income of £35,000 would even after the personal allowance take the taxpayer into the higher rate tax bracket of 40%. (currently income greater then £42,385).
This increase in income could also affect claims for Child Benefit and Income Tax Credits.
Will I pay less tax by using a limited company?
There is no simple answer.
There are a few considerations that will impact on whether a limited company will benefit your tax position, including (but not limited to) how many properties you hold, whether you need the income quickly and for how long you want to retain the properties.
The main advantages of operating a limited company are that 1) they are not affected by the new Mortgage interest relief restriction coming in from April 2017 because interest for limited companies is classed as a business expense and fully deductible against income and 2) companies pay corporation tax at a fixed rate irrespective of the size of the profits. The Corporation Tax rate is currently at 20% reducing to 17% in 2020. This makes the tax rate very attractive compared to 40% for higher rate tax payers and 45% for additional higher rate taxpayers. However the question is how will the money in the company be passed to the individual?
If the money is taken out of the company as a dividend, then currently only the first £5,000 of dividend income is tax free (reducing to £2000 from April 2018). Any dividends taken out more than this amount will either be charged at 7.5% for a basic rate taxpayer, 32.5% for a higher rate taxpayer or 38.1% for an additional higher rate taxpayer. This tax is after the corporation tax at 20% has been paid. If the money is taken as a salary the company would have to operate PAYE and pay Employers National insurance contributions on any salaries paid. This usually in most circumstances works out more expensive than paying dividends. Also, companies do not benefit from the annual allowance of £11,100 against capital gains so the 20% corporation tax is due on the full amount of any gain when the buy to let property is sold.
In addition, companies also must have annual accounts produced and filed with company’s house and prepare and file corporation tax returns.
Interest rates charged on mortgages to companies have historically been higher than to individuals.
Transferring a current buy to let property into a limited company can trigger stamp duty and capital gains tax charges at the time of transfer so advice should be sought before undertaking such a transaction. Due to the complexities of this area it is essential that you seek proper professional advice.
Is inheritance tax paid on a buy to let property?
Yes, any buy to let property that you own will form part of your estate for Inheritance Tax purposes. If you’re operating as a sole landlord – with the buy to let mortgage in your name as an individual and your estate entirely owned by you alone – then you’re liable to inheritance tax if your property value less any outstanding mortgage (or combined value of your estate) exceeds £325,000. If the property is jointly owned with a married or civil partner, then you each have a threshold of £325,000 so the inheritance tax kicks in at £650,000. Anything above these amounts is taxed at 40%.
As Inheritance tax planning is complex you should take advice from a tax or financial expert.
We are here to help so if you are an existing landlord considering whether to switch to a limited company or looking at buying you first buy to let property please get in touch at https://source.investments/contact/