
This article covers the basics of how the various different forms of tax may affect your rental property.[i]
Do you pay Stamp Duty Land Tax on a buy to let property?
Yes, the amount
varies depending on the price of the property and where in the UK it is.
In England and Northern Ireland you’ll pay
Stamp Duty Land Tax, and the current
rates of stamp duty are;
- 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 everything over that.
In Scotland you’ll pay Land and Buildings
Transaction Tax, and the current
rates are:
- 3% tax on the first £145,000
- 5% on the portion up to £250,000
- 8% on the portion up to £325,000
- 13% on the portion up to £750,000
- 15% on everything over that.
In Wales you’ll pay Land Transaction Tax, and the current rates are:
- 3% tax on the first £180,000
- 6.5% on the portion up to £250,000
- 8% on the portion up to £400,000
- 10.5% on the portion up to £750,000
- 13% on the portion up to £1,500,000
- 15% on everything over that.
Anyone buying a second property that isn’t their main residence will be charged these new rates. This will include holiday lets and buying a property for children if the parents leave their name on the title deeds. Stamp duty has to be paid within 30 days of completion of the property purchase although this is usually paid by the solicitor on completion. The amount of Stamp Duty paid is deductible from any capital gains you might make when the property is sold.
Do you pay Capital Gains Tax on buy to let property?
Yes, if you sell
the property for more than you paid for it after deducting costs such as stamp
duty and estate agent/solicitors’ fees. By making a profit, you are essentially
‘gaining capital’, and so the tax applies. However, as an individual you get an
annual allowance to set against any gain.
In the 2019/20 tax year, this allowance is £12,000.
This is a special allowance purely for capital items and is separate from the
annual personal income tax allowance. If the gain is greater than the £12,000
allowance, you will pay tax at a rate of either 18% or 28% on any profit over
£12,000, depending on the amount of income and capital gains you have.
Note that the lower CGT rates of 10% and 20%
announced in the March 2016 budget do not apply to buy to let and second
properties.
What you can do to reduce your CGT liability
There are legitimate ways to
reduce the amount of Capital Gains Tax (CGT) payable:
A loss made on the sale of a buy to let property
in previous tax years
Solicitor fees
Estate agent fees
Costs of advertising the property for sale
Stamp duty
Any expenditure on ‘capital’ items
These expenses can be deducted from your capital
gain. There are also certain tax reliefs available. For example, if the
property was previously your main residence, the gain may be reduced.
Like income tax, any gain is declared on your Self-Assessment
tax return. The tax is therefore 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 May 2018 it is in the tax year to 5th April 2019, so the tax is payable by
31st January 2020.) However, the Government is proposing that, from April 2020,
any tax payable on the profit of the sale of the property will be payable
within 30 days of the date the property is sold.
Do you pay tax on buy to let property income?
Yes. 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:
Interest on buy to let mortgages and other
finance charges (but see below)
Council tax, insurance, ground rents etc
Property repairs and maintenance – however 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
New rules for tax relief on interest payments
came into force from April 2017 which restrict the tax relief given on interest
payments. The restriction is being phased in over 4 years with the aim to only
give basic rate tax relief from April 2020. See our examples overleaf for basic
and higher rate tax payers.
An example of how the new rules could affect you
House is bought for £300,000
80% mortgage is taken for £240,000
Mortgage interest assumed at 4.5% annual mortgage interest is £10,800
Rental yield is assumed at 5%, annual rent is £15,000
Basic rate taxpayer
2017/18 | 2018/19 | 2019/20 | 2020 on | |
Annual rental income | £15,000 | £15,000 | £15,000 | £15,000 |
Mortgage interest payable | (£10,800) | (£10,800) | (£10,800) | (£10,800) |
Reduction in mortgage interest allowance* | £2,700 | £5,400 | £8,100 | £10,800 |
Total rental income on which tax is payable | £6,900 | £9,600 | £12,300 | £15,000 |
Tax at 20% | £1,380 | £1,920 | £2,460 | £3,000 |
Tax
relief at basic rate – 20% of the reduction in mortgage interest allowance | (£540) | (£1,080) | (£1,620) | (£2,160) |
Total tax payable | £840 | £840 | £840 | £840 |
A basic rate tax payer on the face of it will
not pay any more tax under the new rules, but that’s not the whole story. The
new rules change the way income is calculated. Income is now before deduction
of any mortgage interest and other allowable expenses. This increase in income
could affect claims for Child Benefit and Income Tax Credits.
*The reduction in mortgage interest allowance is 25% in 2017-18, 50% in 2018-19, 75% in 2019-20, 100% in 2020 and beyond.
Higher
rate taxpayer
The tax impact of the new interest deduction
rules will be a significant increase to the tax bill for higher rate taxpayers.
In 2020, a higher rate tax payer would pay £2,160 more tax.
2017/18 | 2018/19 | 2019/20 | 2020 on | |
Annual rental income | £15,000 | £15,000 | £15,000 | £15,000 |
Mortgage interest payable | (£10,800) | (£10,800) | (£10,800) | (£10,800) |
Reduction in mortgage interest allowance* | £2,700 | £5,400 | £8,100 | £10,800 |
Total rental income on which tax is payable | £6,900 | £9,600 | £12,300 | £15,000 |
Tax at 40% | £2,760 | £3,840 | £4,920 | £6,000 |
Tax
relief at basic rate – 20% of the reduction in mortgage interest allowance | (£540) | (£1,080) | (£1,620) | (£2,160) |
Total tax payable | £2,200 | £2,760 | £3,300 | £3,840 |
The tax impact of the new interest deduction
rules will be a significant increase to the tax bill for higher and additional
rate taxpayers.
*The reduction in mortgage interest allowance is
0% in 2016-17, 25% in 2017-18, 50% in 2018-19, 75% in 2019-20, 100% in 2020 and
beyond
Is using a limited company better for tax?
There is no simple answer. It depends on a number of factors such as how many properties you hold, whether you need the income quickly and how long you want to hold the properties for and your individual circumstances.
Limited companies are not affected by the new
mortgage interest relief restriction which came into effect from April 2017.
Interest for limited companies is classed as a business expense and fully
deductible against income.
Companies pay corporation tax at a fixed rate
irrespective of the size of the profits. The Corporation Tax rate is currently
at 19% reducing to 18% in 2020. This makes the tax rate very attractive
compared to 40% for higher rate tax payers and 45% for additional higher rate
taxpayers.
The question is how the money in the company is
passed to the individual. If the money is taken out of the company as a
dividend, then from April 2018 only the first £2,000 of dividend income is tax
free. Any dividends taken out in excess of this 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 19%
has been paid.
The money could be taken as a salary; however,
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.
Companies also do not benefit from the
annual allowance of £11,700 against capital gains. So extracting the money for
a sold buy to let property could be less tax efficient than holding the
property as an individual.
As you have to pay the 19% corporation tax on
any gain, no annual allowance is given and you have to pay tax on extracting
the money from the company, whereas even a higher rate taxpayer only pays 28%
on any gain from the sale of a buy to let as an individual. Companies also have
to prepare accounts to be filed with company’s house and prepare and file
corporation tax returns which can be more onerous than self-assessment returns.
Interest rates charged on mortgages to companies
have historically been higher than to individuals so further investigation of
the comparison of the rates charged should be considered alongside the tax
implications.
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 tax advice.
Do you pay inheritance tax on a buy to let property?
Yes, Inheritance
Tax is payable on buy to let properties but the amount changes depending on
your circumstances. A buy to let property that you own will form part of your
estate for Inheritance Tax purposes.
It works like this:
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 you’re in this 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%.
Inheritance tax
planning is complex and definitely something that should be discussed with an Avanti
expert on tax or one of our recommended financial advisers.
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Disclaimer
The information provided here is of a general
nature. It is not a substitute for specific advice on your own circumstances.
You are recommended to obtain specific professional advice from a tax and legal
adviser before you take or refrain from any action. Whilst we endeavour to
use reasonable efforts to provide accurate, complete, reliable, error free and
up-to-date information, we do not warrant that it is such. The information can
only provide an overview of the regulations in force at the date of
publication, and no action should be taken without consulting the detailed
legislation or seeking professional advice. The information, tax rates and allowances are correct as at the
1st September 2018.