Are you fully aware of the tax implications?
If you are considering purchasing a residential buy-to-let property, you may not be fully aware of the tax implications. Usually there will be two taxes that you may have to pay. These are, income tax, which is payable each year based on your income from the property after deducting certain expenses that you have incurred, and capital gains tax, which is payable when you sell the property and is based on the sale proceeds of the property less the cost of the property.
Income tax
Rent will be treated as income and taxed in line with your basic or higher-rate tax bands.
You will, however, be able to offset mortgage interest payments, letting agency costs and maintenance expenses against the taxable rental income.
This makes it more tax-efficient to have a mortgage on your investment property rather than your main home where you can no longer get tax relief on your mortgage.
Rental income should be declared on an annual self-assessment tax return, it may be worth speaking to an accountant to ensure all tax breaks are taken advantage of. Typically there are two types of income that you will receive from your tenants, rent and deposits.
Rent is taxed each year, based on the income that is due to you during a tax year rather on the rent that you actually receive during the year. For example, if a tenant pays you in advance, only that part which falls within the tax year will be taxed in that year. The remainder will be taxed in the following tax year.
Similarly, if a tenant is late paying you, that part which was payable in the earlier tax year will still be taxed in that year. The only exception to this is when a tenant defaults on a payment and you will not be able to recover the amount due.
Deposits are not taxable whilst they are still repayable to the tenant, but once either part or all of the deposit ceases to become repayable, for example, because there has been damage to the property, then this will become taxable at this point.
Capital gains tax
Capital gains tax (CGT) currently becomes payable when you sell a buy-to-let property at a profit. In April 2008, the CGT was changed to a flat rate of 18 per cent. Any gains above the annual £10,100 (20010/11) personal threshold will attract CGT.
However, the new government recently announced plans to raise CGT from 18 per cent on buy-to-let properties.
Prior to April 2008 CGT was charged at up to 40 per cent and taper relief could be applied to reduce this amount, if a property had been owned for more than three years – this is no longer applicable.
CGT gains tax applies to any property which is not your main home, known as the Principal Private Residence (PPR). If you only have one property and it is considered your PPR, then you do not have to pay CGT, however, HM Revenue & Customs may require evidence that you were actually living there.
Buy-to-let owners can reduce a tax bill if they have ever lived there as their PPR and through lettings relief. Everyone’s PPR is exempt from CGT when sold, but any other properties owned attract CGT at their highest rate when sold.
An unmarried couple may each own a home that qualifies as their principal residence but a married couple may only nominate one property and must elect jointly.
It is possible to cut a CGT bill by living in the second property for a period of time. Special rules apply to properties that have been a main residence. The period when it was the main residence is exempt, plus the last 36 months of ownership.
For those who have previously rented out their main residences there is the added benefit of being able to claim up to £40,000 letting relief. This is available to anyone with a share in the property – giving a couple, even if married, up to £80,000 between them.
The amount of private letting relief that can be claimed cannot be greater than £40,000 and must be the lower of that sum, the amount of principal private residence relief being claimed, or the capital gains made during the letting period.
CGT liabilities should be declared annually on your tax return and anyone making a substantial sum from selling a property should seek professional advice.
Stamp duty
The standard stamp duty bands are: 1 per cent on homes worth between £125,000 and £249,999; 3 per cent between £250,000 and £499,999; 4 per cent between £500,000 and £999,999; 5 per cent £1m-plus (from April 2011).
