How to beat the taxman and reduce the costs of your buy-to-let portfolio

Taxman: Hector the taxman from the HMRC wants to know how much money you make from buy-to-let

Taxman: Hector the taxman from the HMRC wants to know how much money you make from buy-to-let

Becoming a buy-to-let landlord can mean reaping a decent return, but it will also add to your tax bill.

If you can find a property in a decent location with good tenants then then you should be able to build up a good income from rent.

But the taxman will want to know about any returns you make. If you don't declare your income properly or capital gains when you sell, you could be in trouble.

We run through the taxes associated with buy-to-let.

Some of these taxes and allowances are changing from April 2016, see the round-up at the bottom of the article which explains this.

Mortgages and tax 

Firstly, there is something you need to know about mortgages that makes it obvious you have been letting a property.

You need a different type of mortgage to the type you would get for your own home.

Lenders will also want to know if you have begun renting out your home because this is usually not allowed under the terms and conditions of a residential mortgage. Often you will have to move to a buy-to-let rate.

Most banks and building societies offer buy-to-let mortgages. The rates tend to be higher than residential mortgages, which reflects risks such as tenants not paying rent and you defaulting.

Buy-to-let is treated as an investment so is subject to income tax on rent and capital gains tax on sale. You will also have to pay stamp duty on the property purchase.

Inevitably there will be those who think they can get away with dodging some of the taxes levied on buy-to-let, perhaps not paying tax on rental income, or a capital gain made. 

In the past some have, but the taxman has cracked down very heavily on this in recent years -actively making landlords a target. 

At the same time, mortgage lenders have also cracked down on those letting property but staying on a residential mortgage. 

You are far more likely to get caught out if you try to skip tax today. 

Stamp duty

The first tax you will need to pay if you are building your buy-to-let portfolio is stamp duty when you purchase a property, just as you do with a residential home.

WHAT THE EXTRA 3% STAMP DUTY MEANS FOR LANDLORDS FROM APRIL 2016

Currently, buyers pay no stamp duty on the first £125,000, then 2 per cent on £125,000 to £250,000 and 5 per cent above £250,000 to £500,000, rates continue to step up above this.

For those buying a buy-to-let property or second home, stamp duty will now be 3 per cent on homes between £40,000 and £125,000, 5 per cent to £250,000 and 8 per cent to £500,000. 

For those snapping up a £275,000 home, the current rate of stamp duty means a £3,750 stamp duty bill.

This is worked out by:

0% on the first £125,000 = £0

2% on the next £125,000 = £2,500

5% on the final £25,000 = £1,250

Total SDLT = £3,750

But adding the 3 per cent surcharge will see the price of the tax rocket for landlords.

3% on the first £125,000 = £3,750

5% on the next £125,000 = £6,250

8% on the final £25,000 = £2,000

Total SDLT = £12,000 

The good news is that you can claim back the stamp duty by offsetting it against any capital gains tax liability when you sell. 

Stamp duty was previously levied slab style, as a percentage on the whole purchase price, but that was changed by the Autumn Statement in December 2014.

Buyers now pay stamp duty progressively based on how much over a threshold their purchase is.

Since December 4 2014, bands are now 0% up to £125,000; 2% to £250,000; 5% to £925,000; 10% to £1.5million and 12% above that.

Under the new system anyone buying a home costing under £937,000 should pay less or the same, Treasury figures show.

Those buying a £200,000 home will pay £1,500 instead of £2,000. 

The big win though is for those previously caught in the 3% tax trap, someone previously hit with an £8,250 bill on a £275,000 home will now pay £3,750.

Meanwhile, those buying a £600,000 home will now pay £20,000 in tax, compared to £24,000 before  

Use our calculator to work out how much stamp duty you will have to pay on your property

This is all set to change from April 2016 when landlords and people buying second homes will have to pay an extra 3% stamp duty.

Income tax on buy-to-let

You will have to complete a self-assessment tax return to pay income tax on any rent you receive.

The amount you pay will be determined on your income tax banding, so if you are a basic rate taxpayer you pay 20 per cent, 40 per cent for a higher rate and 45 per cent for the additional rate.

However, you can reduce the amount of tax you pay by offsetting any ‘allowable expenses’ that HMRC will let you claim for.

The big break is that you can claim for interest on buy-to-let mortgage payments, allowing you to offset the mortgage interest against rental income and only pay income tax on the gap between the two - ie your profit.

But it is vital to understand that this is changing. From 2017 this will be limited to 20 per cent tax relief and the calculations will be different. This could severely dent landlords' rental profits. We explain more at the bottom of this article.

You can also currently offset some other things as allowable expenses. These include any arrangement fees for setting up loans for the property.

Any maintenance costs on the property and letting agent fees can also be claimed for, with landlords able to claim an automatic 10 per cent wear-and-tear per year on furnished property.  This is changing from April 2016, and landlords can only claim expenditure that they actually make.

You can also claim for buildings and contents insurance, council tax and utility bills if your tenant is not paying them.

Check with an accountant or HMRC if you are unsure what to claim for. 

> Read the official guide to allowable expenses here 

Capital gains tax

BUY-TO-LET YIELD CALCULATOR

Mortgage calculator

This calculator shows the rental return on your investment property as a percentage of its value

When you come to sell your buy-to-let property, there will be capital gains tax to pay on any profit.

CGT kicks in when you sell a buy-to-let property at a profit of more than the annual allowance, currently £11,100 in 2015/2016. 

This can be combined to £22,200 for married couples or civil partners. 

It applies to any property which is not your main home, known as your Principal Private Residence. This gets a special exemption.

CGT is levied at 18 per cent or 28 per cent depending on whether people are basic rate or higher rate taxpayers.

However, gains are added to income to deliver a total amount that decides this. This means that in practice most landlords making decent profits should pay the 28 per cent rate.

If you only have one property and it is considered your principal home, then you do not have to pay CGT, however, the taxman may want evidence that you were actually living there. Married couples and civil partners can only have one PPR between them.

Cutting tax on buy-to-let profits 

There are two reliefs you can get on your CGT bill.

Private residence relief 

If you have a former home that you let and then sold, you may be able to reduce your capital gains tax bill.

This relief was initially designed to protect those who had to move for work but were unable to sell their homes.

With the emergence of buy-to-let and the pre-2007 property boom it became increasingly used by those who had simply chosen to keep their old homes as investments, perhaps when moving in with a partner and eventually marrying.

If at any point a property has been its owner's only or main residence, the last 18 months of ownership qualify for a tax break known as private residence relief, which makes it free of capital gains tax over that period.

This is less generous than the position before April 2014, where former owners could be exempt for the last three years of ownership. 

For the purposes of tax, HMRC divides any gains made on property ownership evenly over the years. 

If you own two properties, you can elect which one is your main residence, but must tell HMRC within two years of purchasing the second one. You can switch the main residence but must keep HMRC informed by making a written election, known as a PPR election. 

These rules have been further strengthened as part of reforms from April 2015 to make sure foreign owners who buy property in the UK as second homes pay capital gains tax. Now you can only claim PPR on UK property where you are tax resident in the UK or you spend more than 90 nights in your UK property and actually occupy it as a home.

> Accidental landlords hit harder than the oligarchs as valuable CGT break is halved

Lettings relief 

A further element called lettings relief can further reduce your CGT bill.

Lettings relief applies where the property has at some point been an individual's only or main residence 

Letting relief is worth the lowest of three amounts: private residence relief already claimed, the value of the increase in capital gains which occurred during the period when the property was being let, or £40,000.

When combined with the annual CGT allowance, these two reliefs can often take bills down to zero. 

Offsetting stamp duty and estate agent's fees 

You can reduce your CGT bill by deducting some of the expenses associated with buying and managing a property.

You can offset costs such as the stamp duty paid when you purchased the property as well as solicitors’ fees, estate agent’s fees to market the property, refurbishments costs that are capital in nature and have not been offset against the rental income and surveyors' fees if a survey was carried out when you purchased the property.

You may also be able to offset losses on other property against your capital gains tax bill.

Inheritance tax

When you die your buy-to-let portfolio will form part of your estate. 

This means whoever inherits the portfolio may have a tax charge to pay of 40 per cent if the total estate exceeds £325,000 or £650,000 for married couples.

There are ways to reduce your inheritance tax liability by making gifts to relatives and putting bits of your estate in trust. This is much more complex with a property than it is with cash, shares or funds, which can be passed over in small chunks.

From April 2017, each individual will be offered a family home allowance, starting at £100,000 and moving to £175,000 in 2020, so they can pass their home on to their children or grandchildren tax-free after their death.

This allowance will not apply to buy-to-let properties. 

The family home allowance will be added to the existing £325,000 Inheritance Tax threshold up to a total of £1million, meaning the total tax-free allowance for a surviving spouse or civil partner will be up to £1million in 2020-21. The allowance will be gradually withdrawn for estates worth more than £2 million, any buy-to-let properties will form part of this estate.

Find an independent financial adviser or solicitor to help with reducing your inheritance tax bill.

RESTRICTING RELIEF FOR BUY-TO-LET LANDLORDS FROM 2016

Chancellor George Osborne announced a number of measures in his 2015 Budget in July aimed at curbing the tax breaks landlords enjoy on their buy-to-let properties. 

From April the 'wear and tear allowance' will be scrapped. The allowance means landlords can currently lower their tax bill to pay for upkeep of their property, regardless of whether they have made any changes.

From April 2016, the tax relief will only apply only to the costs they actually incur while doing so.

A much bigger change arrives a year later. From April 2017 landlords will no longer be able to deduct finance costs from their property income to arrive at their property profits. They will instead receive a basic rate reduction from their income tax liability for their finance costs.

The Treasury defines finance costs as mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans. 

While private landlords can currently claim tax relief on monthly interest payments at up to the 45 per cent top level of tax, from April 2017 this will start to be reduced to 20 per cent.

 Landlords will be able to obtain relief as follows:

  • In 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
  • In 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
  • In 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
  • From 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction


 

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