Buy-to-let and tax
I’d like to share a really useful and unusually clear note from St James’s Place Wealth Management that I was sent this week. It answers a question I am often asked – “what’s the situation with buy-to-let and tax these days?”. I hope you will find this as helpful as I have;-
WHAT IS STAMP DUTY LAND TAX?
Stamp Duty Land Tax is payable on the acquisition of properties, including buy-to-let properties. The amount varies depending on the price of the property.
The current rates of Stamp Duty Land Tax (SDLT) in England (from 1 April 2018) for buy-to-let properties where the individual already owns at least one property 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
Any clients purchasing an additional property will be charged these rates. This will include holiday lets but also buying a property for children if the parents leave their name on the title deeds or vice versa. SDLT has to be paid within 30 days of completion of the purchase of the property, although the amount of SDLT paid is deductible from any capital gains made when the property is sold or gifted.
Note that different rates apply in Scotland and, from 1 April 2019, Wales.
CAPITAL GAINS TAX
The sale of property (excluding your main residence) for more than was paid for it, after deducting allowable costs such as SDLT and estate agent/ solicitor’s fees, will result in a capital gain. An individual has an annual allowance to set against any gain and, in the 2018/19 tax year, this allowance is £11,700. Whilst lower Capital Gains Tax (CGT) rates of 10% and 20% were announced in the 2016 Budget, these do not apply to disposals of residential properties. As a result any property gains are chargeable at 18% or 28% depending on whether the property owner is a basic or higher rate taxpayer.
Reducing any CGT liability
There are legitimate ways to reduce or defer the amount of CGT payable. These include:
• Offsetting any loss against a gain made on the sale of a buy-to-let property in previous years
• Claiming allowable expenditure, which may typically include:
– Solicitor’s fees [and your buying and selling agents fees]
– Costs of advertising the property for sale
– Any expenditure on ‘capital’ items
• Investing funds equivalent to any gain made into an appropriate tax-efficient investment vehicle.
Any gain is declared on your Self Assessment tax return. The tax is therefore payable by the 31 January in the year after the tax year in which the property was sold. (For example if a property was sold on 4 May 2016, it is in the tax year to 5 April 2017 so the tax is payable by 31 January 2018.) However, from April 2019 the government intends to require a payment on account, within 30 days of a sale, of any CGT due on the disposal of a residential property.
INCOME TAX ON BUY-TO-LET INCOME
Income received as rent is taxable and should be declared as part of the Self Assessment tax return. Tax on income is then charged in accordance with the investor’s Income Tax banding (20% for basic rate taxpayers, 40% for higher rate, and 45% for additional rate).
It is possible to reduce the tax payable by deducting certain ‘allowable expenses’, which typically include:
• Interest on buy-to-let mortgages and other finance charges (but see below).
• Council Tax, insurance, ground rent etc.
• Property repairs and maintenance – however, large improvements such as extensions will not be deductible for Income Tax. 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 for a letting agent.
• Other property expenses, including building insurance premiums.
From April 2017 the government introduced a new £1,000 allowance for individuals with property income below the level of the allowance will no longer need to declare property income or pay tax on that income.
‘Wear and Tear Allowance’
Historically, it was possible for buy-to-let landlords to claim a ‘wear and tear allowance’, which allowed them to deduct 10% of the net rent from the rental income subject to tax to represent the replacement of furnishings etc. and therefore reduce their income tax liability on an annual basis. From 2016/17 onward, the wear and tear allowance has been scrapped and they can only deduct expenses genuinely incurred on the replacement of qualifying expenditure which is likely to increase the landlord’s tax liability each year.
OTHER TAX CHANGES INTRODUCED FROM 6 APRIL 2017
The Finance (No. 2) Act 2015 included provisions that changed the way in which interest is deductible when calculating the profits from rental property. These changes have had effect since 6 April 2017 and will gradually shift the allowable deduction to zero with effect from the tax year 2020/21. During this period a new tax reduction will be introduced to give relief at the basic rate. This will work as follows:
• In 2017/18, the deduction from rental income is restricted to 75% of finance costs, with 25% being eligible for a basic rate tax credit.
• In 2018/19, a 50% finance costs deduction is available, with 50% as a basic rate tax credit.
• In 2019/20, 25% of the finance costs are available as a deduction, with 75% given as a basic rate tax credit.
• From 2020/21 all financing costs incurred will only be given a basic rate tax credit.
The following tables illustrate how this will work for higher and additional rate tax payers.
On the face of it, a basic rate taxpayer will not pay any more tax under the new rules, but this is not necessarily the case. These new rules change the way income is calculated so, by way of an example using the above table:
If the individual with these properties had £27,000 of employment income, and rental income of £45,000,
with mortgage interest at £30,000, then under the old rules the net profit of £15,000 and £27,000 employment
income would all be taxed at the lower rate of 20%.
Under the new rules, from 2020 the income from rental income of £45,000 and employment income of £27,000 would, even after the personal allowance, push the taxpayer into the higher rate tax bracket.
WOULD USING A LIMITED COMPANY BE AN OPTION?
There is no simple answer to this question. It will depend upon a host of different factors, including:
• The number of properties held
• How long the properties will be held for
• Level of rent and other earnings/income
• The extent of leveraging on the properties
• The landlord’s general personal circumstances
Limited companies are, however, not affected by the new mortgage interest relief restrictions and interest for limited companies is classed as a business expense and fully deductible against income. Furthermore, companies pay Corporation Tax at a fixed rate, irrespective of the size of the profits, with Corporation Tax rates reducing to 17% in 2020. This makes the tax rate very attractive compared to 40% for higher rate taxpayers and 45% for additional rate taxpayers.
Conversely, it would also be important to address how the money (rental income) in the company is passed out to the investor. If money is taken out of the company as a dividend, currently only the first £5,000 of dividend income is tax-free and this reduces to just £2,000 from 6 April 2018. Any dividends taken out in excess of this will be charged at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers or 38.1% for additional rate taxpayers. This tax is after the Corporation Tax has been paid. Alternatively, money could be taken as a salary; however, the company would then have to operate PAYE and pay employers’ National Insurance contributions on any salaries paid. This usually works out more expensive than paying dividends.
It should also be noted that transferring an existing buy-to-let property into a limited company may not only cause practical difficulties where there is a current mortgage on the property, it can also trigger Stamp Duty Land Tax and Capital Gains Tax charges at the time of transfer. Although it may be possible to undertake planning to limit such liabilities, it is essential that professional advice is sought before embarking on the limited company route.
If you require further information around the taxation implications of buy-to-lets please ask and of course do feel free to contact a St. James’s Place Partner.
[Image ‘borrowed’ from Jude Little aka ‘Big Sister Jude’ and on Twitter @BigSistersTips. Well worth checking out].