Should five percent appear too small
Be thankful I don’t take it all
‘Cause I’m the taxman, yeah, I’m the taxman….Taxman – By The Beatles
Tax is a pretty ‘dry’ subject and is never going to be the most exciting topic of conversation, but the property market does shoulder its fair share of the UK tax burden.
It’s therefore worth knowing what the main taxes are that affect property investors and landlords so that informed business and strategic decisions can be made.
This is a brief guide to UK property tax and offers some pointers on how to reduce your tax liability.
The Four Main Types of UK Property Tax
|Stamp Duty||When You Buy a Property|
|Income Tax||Rental Profits – Whilst You Own a Property|
|Capital Gains Tax||When You Sell a Property|
|Corporation Tax||If You Own Property Within a Company|
Stamp Duty Land Tax to give it its full title (often also abbreviated to SDLT) is payable when purchasing properties over a certain value and escalates at increasing thresholds.
Currently, in an attempt to maintain buoyancy in the property market during the Coronavirus pandemic, the initial residential property value threshold for SDLT to be payable is £500,000.
After 01 April 2021 this figure will reduce to its previous figure of £125,000 and the thresholds will be:
|Property or lease premium or transfer value||SDLT Rate||BTL SDLT Rate|
|Up to £40,000||Zero||Zero|
|£40,001 to £125,000||Zero||3%|
|The next £125,000 (the portion from £125,001 to £250,000)||2%||5%|
|The next £675,000 (the portion from £250,001 to £925,000)||5%||8%|
|The next £575,000 (the portion from £925,001 to £1.5 million)||10%||13%|
|The remaining amount (the portion above £1.5 million)||12%||15%|
As buy-to-let (BTL) property investors and landlords, when we start calculating the ROCE/ROI on our next deal, we need to bear in mind that we have to pay an additional 3% of SDLT at every threshold level (with the exception of purchases up to £40k) as detailed in the table above.
This applies if your purchase is for your second (or more) property.
To make life easier, the government have produced a SDLT Calculator, which will help you to work out your exact SDLT liability on that next deal at any time, reflecting all the current rates and thresholds.
On the governments SDLT website there is also information relating to the distinctions between England and Northern Ireland, Scotland (where SDLT is replaced by Land and Buildings Transaction Tax) and Wales (where it is replaced by Land Transaction Tax).
Some good news first: The first £1,000 of your income from property rental is tax-free. This is your ‘property allowance’.
You must report it on a Self Assessment tax return if it’s:
- £2,500 to £9,999 after allowable expenses
- £10,000 or more before allowable expenses
As is always the case, your rate of income tax will vary depending upon your actual overall income level (including income from property, your job and any other sources).
Also, at the time of writing (November 2020), your first £12,500 of total earnings (including rental income) is tax free.
We cannot move on from income tax without touching upon Section 24 – The removal of mortgage interest relief.
Once upon a time, it was possible for property investors/landlords to offset the interest part of a BTL mortgage against tax.
This is one reason why interest only mortgages became so popular.
However, thanks to George Osborne and the summer budget of 2015, this option has now been removed and we no longer get full mortgage interest relief from HMRC.
It has been replaced by a ‘tax reducer’, which is a 20% allowance that is deducted from the finance cost portion of a BTL mortgage.
Section 24 has resulted in a significantly higher tax burden on property investors, particularly those falling into the higher rate tax bracket.
However, being a resilient and adaptable lot, investors’ strategies have been ammended accordingly.
When section 24 was introduced, it was framed by the government as a means to curb the booming buy-to-let market and help first-time buyers. In reality, it was more likely a tax grab!
What we have actually seen is landlords putting rents up to compensate for the loss of income, which has meant those prospective first-time buyers have found it more difficult to save for a deposit.
We have also seen a boom in strategies like property sourcing, rent-to-rent, serviced accommodation and purchase lease options.
As we are probably all familiar with income tax generally, as it affects everyone who receives an income (over £12.5k), we won’t spend any more time expanding upon it here.
What Happens if a Landlord Makes a Loss?
If allowable expenses (see below) exceed rental income during a tax year, that loss can be offset the following year.
Any such loss cannot be ‘saved-up’ to use at any point in the future (e.g. to avoid moving into a higher income tax band). It must be applied the following year, until all losses are exhausted.
Capital Gains Tax
Currently, this topic is a bit of a hot potato, following a Rishi Sunak-commissioned review of capital gains tax, which recommends slashing the annual allowance and aligning rates more closely with income tax in a move that could raise billions of pounds for the Exchequer.
There is another report to follow next year, so it is unlikely that the laws around capital gains tax will dramatically change anytime soon.
That said, it is worth bearing in mind that changes are on the horizon and it is unlikely that property investors will be treated favourably. (Think Section 24!)
Anyone who has been in the property business for any length of time will understand the need to roll with the punches and adapt their strategy accordingly.
Any forthcoming changes to capital gains tax will just present another hurdle for us to traverse. There may even be opportunities available to some.
As things currently stand, when you sell a property that’s not your home – a house you bought, renovated, and let out for instance – and make a profit, you may be liable for capital gains tax.
You may also be liable to pay capital gains tax on inherited property, if you sell it.
At the time of writing, the annual exempt amount for individuals is £12,300, but as we have already noted, this looks set to change before too long.
As with SDLT the government provides detailed guidance on how to work out your potential capital gains tax liability, which can be used in your decision-making process, before you commit to disposing of an asset.
If you are a higher, or additional rate taxpayer, the level of capital gains tax is currently set at 28% for property disposals.
For basic rate taxpayers, the level is 18% but will also depend upon the amount of gain.
i.e. Accounting for your allowance, any portion of your gain that takes you above the basic rate tax threshold will then be charged at 28% for property disposals.
If, at some point you are fortunate enough to realise a significant capital gain, it can be tempting to immediately dive in to the next deal and re-invest your profits.
Before doing so, we would advise you to make sure that you understand your tax liability and when payment to HMRC will become due.
More importantly, make sure that you put enough money to one side to pay what is owed.
For UK residents the deadline for payment is within 30 days of completing the sale.
Lettings relief is a reduction in capital gains tax for landlords who have lived in the properties they let out.
From April 2020, lettings relief is only be available for live-in landlords who are in shared occupation with their tenants.
You may qualify for private residence relief. This is a percentage reduction in capital gains tax, based on the number of years you lived in a property plus the last nine months before you sold it.
Let’s say you lived in a property for ten years, then let it out for another ten.
You would get private residence relief for those first ten years, plus the last nine months you rented it out.
Ten years and nine months is 53.7 per cent of the time you owned the property.
You’d therefore gain private residence relief on 53.7 per cent of the gain you make when you sell the property.
Businesses are taxed differently from individual taxpayers, instead of income and capital gains tax they pay corporation tax.
This can be beneficial for property investors, who own property within a limited company.
Depending upon their strategy….!
Before we get on to the relative merits of owning property within a limited company, if this is something you are considering, information on how to set up a limited company and register for corporation tax can be found here.
Corporation tax rate has been 19% for all limited companies since April 2016. Prior to this, the rate varied depending on the company’s profits. (Click this link for up-to-date rates and allowances).
As an individual, a private landlord’s tax year runs from 06 April – 05 April each year, whereas companies are chargeable for corporation tax based on an accounting period which the directors of the company can select as they wish.
This can provide some flexibility to the company directors’ providing opportunity for better commercial and tax planning.
One disadvantage of corporation tax vs income tax is that within a limited company there is no tax free allowance. As soon as a company starts to make a profit, it will be taxed on that profit at the current corporation tax rate.
However, one major advantage to owning property within a company is that Section 24 does not apply, which goes some way towards explaining the rapid growth of property companies in recent years.
Another strategic advantage to having a property company, rather than buying and selling property as an individual is if you are intending to ‘flip’ properties. i.e. Buy, re-furbish and sell properties, rather than keep hold of them.
As we have already mentioned there is the potential for a significant capital gains tax liability if you were to buy and sell a lot of properties during the tax year and make a decent profit on each sale.
If those same properties were bought, re-furbished and sold by a company, the profit would be just that; ‘profit’ and would be taxed at the current corporation tax rate.
This could (potentially) be less than the rate of capital gains tax.
The reason it is ‘potentially’ less is because it makes a difference if you are a basic, higher, or additional rate taxpayer.
It will also be influenced by the exact level of gain/profit. Individuals would also need to factor in their capital gains tax allowance.
If you are a higher rate taxpayer, owning a limited company can provide some flexibility, in that:
- You can pay yourself a salary within the basic rate of income tax.
- Have your partner claim Marriage Allowance, or pay your partner a separate salary.
- Pay profits as dividends to all the individuals with a share in the company.
- Shares can be bought, sold and transferred if you want to bring other family members on board.
Allowable Expenses and Business Costs
Whether we own property as an individual, or via a company structure, we can minimise our tax liability by ensuring that we claim for all our allowable expenses.
There is a lot more to property ownership than keeping on top of maintenance issues, or taking over a derelict and spending a chunk of money to bring it back into use.
The key message here is to make sure that you claim for absolutely everything possible.
We would recommend that you take professional advice:
- there are sure to be things that you can claim for that you might not otherwise think of, as well as things that you may think you can claim for, but that are not, in fact, allowable.
In property, as with any other investment, there will always be an element of risk.
Only by understanding the risks, we can protect ourselves against the downside and maximise our profitability.
There is no doubt that legislation in the buy-to-let market is volatile, with new laws being introduced often.
This includes frequent changes to how income from property is taxed.
In order for us to understand the risks around property tax, we can either get educated ourselves, or secure professional help.
Either way, it is important that we always keep abreast of current legislation.
If we choose to go down the route of retaining an accountant, it is important to choose one who thoroughly understands the property market specifically.
They must also be proactive in keeping up-to-date with any and all of the changes as and when they happen, so that they can guide their clients on how to tailor their strategies accordingly.
Tax avoidance is illegal. We should all pay what is expected of us. However, it would be imprudent if we did not protect ourselves by minimising our tax liability.
If we maximise our profits (individual, or company), by only paying the tax we owe and not a penny more, we can re-invest those profits into our portfolios, thus creating more wealth and ultimately paying more tax.
Having to pay more tax, as long as it’s the right amount of tax, is really not such a bad problem to have!
Disclaimer: Golden Egg Property Ltd. are not tax specialists, or advisors. The information contained herein is for information only. Individuals' circumstances vary and therefore, you should always seek independent, qualified financial advice before entering into any investment projects.