Tax is an aspect of residential property investment which is often overlooked. There are many twists and turns to consider at all levels, whether for income tax, capital gains tax or inheritance tax. Getting the ownership structure right ensures all tax relief, allowances, and claims are made.
This section summarises some of the main aspects of the principal areas of property tax. There are many detailed aspects to consider at each stage. It is essential to obtain sound professional advice if there are any doubts about the applicability of any rule. Tax decisions can be influenced by other income and assets the taxpayer has and will not necessarily be the same for every property investor.
All areas of tax require the practice of good record-keeping (this is equally applicable when a property is sold). It is essential that complete and accurate records are kept of all income and expenditure, perhaps maintaining a separate bank account so that all of the information is readily available to allow the taxpayer to claim the maximum deductions and pay the minimum amount of tax. Failure to keep adequate records can result in penalties.
If the landlord is a new property investor, the landlord should notify HM Revenue & Customs (HMRC) immediately of the new source of income that the landlord is now receiving. The tax is computed through an annual tax return sent to HMRC.
Income tax is payable on profits from the property-renting business by computing the total of rents receivable less expenses. Tenants' deposits do not count as income. Typical expenses which the landlord can deduct include:
repairs and maintenance (though not initial expenditure needed to bring the property up to a letting standard or improvements)
- ground rents
- service charges
- contents and building insurance
- managing agent's fees
- legal fees for tenancy agreements
- HMO licence costs
- water rates
- Council Tax
- accountancy fees
- subscription to a landlord association;
- certain motor and travelling expenses
This list is not exhaustive and can vary in individual circumstances.
Mortgage interest is no longer allowable as a deductible expense, meaning the landlord got the benefit at the highest rate of tax they paid. In the transition between 2017 and 2020, the new scheme will add the rent net of allowable expenses to the landlord's other income and then it will be taxed. There will then be a 20% allowance for mortgage interest. This has two effects. Firstly, landlords who pay tax at higher rates will only get a tax deduction at the basic rate. Secondly, some people who were not higher rate taxpayers may find they now pay tax at the higher rate as the rent (before deduction of mortgage interest) will be added to their other income. Landlords should seek specialist advice on tax to ensure the correct amount is paid.
On the question of repairs and maintenance, it is essential to distinguish between repair items and improvement items. Redecorating rooms, changing windows from single to double-glazing, or replacing a defective roof are examples of repairs that will be allowable. The addition of another floor to the building or a new conservatory would not qualify. The landlord would only receive tax relief on the property's eventual sale, set against the eventual capital gain.
Where properties are owned in joint names, the joint owners can share the profits or, in certain circumstances, be wholly attributable to one or other joint owners.
Where a husband and wife jointly own a property, the income is assessed equally, even if the actual ownership proportion is not equal, unless they elect otherwise.
For Capital Gains Tax purposes, proportionate ownership is essential. The joint owners would share any capital gain between their respective proportions giving rise to multiple tax-free allowances.
It may be worthwhile for a limited company to be brought into the structure in certain circumstances. It is usually sensible for the properties to be held in individual or joint names, but these can be sub-let to a company that lets the properties. Landlords should seek professional advice to look at the best structure for any given landlord to own investment properties.
Capital Gains Tax
Capital Gains Tax (CGT) is a tax on the gain or profit made when shares or property are sold, given away or otherwise disposed of. A tax-free allowance and some additional reliefs can reduce a Capital Gains Tax bill.
Capital Gains Tax is one of the most critical taxes to consider as property prices will usually rise over the long term. As the amounts at stake are potentially significant, it is vital to ensure that all available tax relief and allowances are taken advantage of. Many offer scope for substantial reductions in the ultimate amount of tax to be paid.
The basic concept is quite simple: the final price received for the property when it is sold (after deducting legal costs and agent's fees) is compared with what the property cost initially (including any legal fees and Stamp Duty). The profit or 'gain' is calculated on which tax is levied. There are then potential deductions and tax relief available, the most important of which are as follows:
the cost of any improvements to the property whilst under ownership can be deducted (but not the cost of repairs which has previously been set off against Income Tax)
if the owner has occupied the property as an owner-occupier at any time, then there are two additional very valuable reliefs:
- lettings relief whereby up to a certain amount of any gain per owner can be tax-free
- a proportionate principal private residence relief
- if you owned the property at March 1982, its value at that date is substituted for the original cost of the property in calculating the ultimate gain
- set value of any capital gains in a single tax year is tax-free per individual (not per property), tax only being charged on any gain above that value
- if there are two properties which have been used as a residence (e.g. one in London and one in the country), it is worthwhile making a principal private residence election on one of those properties to maximise capital gains relief. This will also reduce the potential CGT payable if one of the properties is let at any time in its ownership.
Where a property is owned at the date of death, the value of that property forms part of the estate and is potentially liable to Inheritance Tax (IHT). If the property is left to a spouse in a will, then no IHT will be payable until the spouse's death.
There are ways of reducing the Inheritance Tax liability, and the landlord should draw up a tax-efficient will to ensure maximum use of IHT allowances. Wills and trusts are specialist areas where it is essential to obtain professional advice, and advice will vary depending on the individual's circumstances.
The purchaser's Stamp Duty Land Tax (SDLT) is payable within 30 days of the purchase, so this should be taken into account when budgeting for a purchase. No Stamp Duty is payable below the prevailing threshold, but above the nil-rate threshold, the applicable rate of SDLT will depend upon the price paid. There are reliefs and exemptions available for certain circumstances. The value of any fixtures, fittings or furniture included in the purchase can be excluded from the purchase price in calculating the Stamp Duty payable. However, the Stamp Duty Office will look at any apparent overloading.
Stamp duty for second homes attracts an additional premium of 3% over and above the regular rate, which means most landlords will have to pay this premium, as will homeowners buying a second home.
SDLT is often being reviewed, and you should consult a tax specialist.
Value Added Tax
Under normal circumstances, landlords cannot register for Value Added Tax (VAT) concerning their residential properties, as residential rental income is exempt from VAT. This means that any VAT incurred cannot be reclaimed. However, landlords who are VAT-registered in their self-employed businesses may be able to claim some VAT incurred.
A special VAT rate of 5% is available on the renovation or alteration of a single household dwelling that has not been lived in for three years or more. This is a valuable saving over the usual 20% rate.
More tax information can be obtained from a local tax office or visit HM Revenue & Customs website at www.hmrc.gov.uk. Copies of leaflets on taxation of rents and other tax matters can be downloaded from HMRC's website or requested by phoning the Order Line on 08459 000 404.