Tax on buy-to-let and how to cut your bill

Becoming a buy-to-let landlord can mean reaping a decent return, but it will also add to your tax bill.

If you can find a property in a decent location with good tenants then then you should be able to build up a good income from rent.

But the taxman will want to know about any returns you make. If you don’t declare your income properly or capital gains when you sell, you could be in trouble.

We run through the taxes associated with buy-to-let.

Some of these taxes and allowances have changed, so make sure you are up-to-date with them.

 Becoming a buy-to-let landlord can make you a good return, but it will also add to your tax bill

The taxman and buy-to-let

The taxman has taken a greater interest in people renting our homes in recent years.  

To purchase a buy-to-let you need a different type of mortgage to the type you would get for your own home.

Lenders will also want to know if you have begun renting out your existing home because this is usually not allowed under the terms and conditions of a residential mortgage. Often you will have to move to a buy-to-let rate, or get permission to let.

Most banks and building societies offer buy-to-let mortgages. The rates tend to be higher than residential mortgages, which reflects risks such as tenants not paying rent and you defaulting.

Buy-to-let is treated as an investment so is subject to income tax on rent and capital gains tax on sale. You will also have to pay stamp duty on the property purchase.

Inevitably there will be those who think they can get away with dodging some of the taxes levied on buy-to-let. In the past some have, but the taxman has cracked down very heavily on this in recent years – actively making landlords a target. 

At the same time, mortgage lenders have also cracked down on those letting property but staying on a residential mortgage. 

You are far more likely to get caught out if you try to skip tax today. 

Stamp duty

The first tax you will need to pay if you are purchasing a property to start a buy-to-let portfolio is stamp duty when you purchase a property, just as you do with a residential home.

The bad news is that stamp duty has been increased in recent years for buy-to-let and second homes. A change arrived in April 2016 that added a 3 per cent surcharge to all the stamp duty bands – in some cases this trebles the bill. 

The good news is that the first £500,000 of the purchase price is currently exempt under the rules of Treasury’s stamp duty cut.

> Work out your potential bill with out stamp duty holiday calculator 

So while they will still have to pay the 3 per cent surcharge, landlords will now see their stamp duty bill significantly reduced when purchasing new property thanks to the Chancellor’s measures. 

While many home buyers particularly in the South East and London will undoubtedly benefit, the average landlord purchase will also see big savings.

For example as illustrated in the chart below a £400,000 second home will now only carry a stamp duty bill of £12,000 rather than £22,000.

Tax on buy-to-let and how to cut your bill 1

While this is still £12,000 more than a residential purchase due to the 3 per cent surcharge, the landlord will still now save £10,000, the same as a standard home buyer would  by not paying any tax at all.

This relief will be in place until 31 March of next year. 

You can claim back some stamp duty by offsetting it against any capital gains tax liability when you sell. 

Tax on rent 

A recent change landlords will still be feeling is the replacement of mortgage interest tax relief with a 20 per cent credit. 

In the past, private residential landlords with a mortgage on their buy-to-let property could simply deduct their mortgage interest from rental income before calculating tax.

This all changed in April 2017 when a new regime was brought to phase out this relief, replacing it eventually with a 20 per cent tax credit and calculation that means most landlords will pay more in income tax.

The change largely affects landlords paying higher rate tax, who will now pay tax on rental income based on revenue rather than their profit after mortgage interest is paid.

It can also affect basic rate taxpayers, who may find themselves pulled up a tax band by the way the calculation is done. 

For example, under the old system a basic rate tax paying landlord with a salary of £25,000, rental income of £15,000 from their buy-to-let property and mortgage interest payments of £10,000 would have been able to subtract those interest payments from the rental income, bringing the taxable amount down to £5,000.

Added to their salary their taxable income would have been £30,000. Once the personal allowance of £12,500 has been subtracted, this would bring their total taxable income down to £17,500.

Overall, on this amount of taxable income a basic rate taxpayer would have paid a total of £3,500 in tax.

This has all changed now that the new fiscal regime has been brought in.

From now on, landlords will get no deduction for their interest cost and just a 20 per cent credit on the whole amount.

Very little changes for our previous example of a basic rate tax paying landlord with a salary of £25,000, rental income of £15,000 and mortgage interest payments of £10,000.

Under the new regime, they would be paying tax on the full £15,000 rental income. They would also get the 20 per cent tax credit on their interest payments worth £2,000.

With a salary of £25,000, our landlord’s taxable income would now be £40,000.

Take away the £12,500 personal allowance and you get the final taxable income of £27,500, 20 per cent of which is £5,500.

With the tax credit this is reduced to £3,500, the same amount as before.

But higher and additional rate tax payers will almost certainly end up paying more – and as rental income is now added to income before the tax credit is used, it can push people up a tax bracket.

The example below shows how the phasing out of mortgage interest tax relief would affect a 40 per cent tax payer with £3,000 taxable income: 

How has mortgage interest tax relief been phased out? 
Current 40% tax payer Old System New System Buy to Let Tax Bill Net Profit
16/17 100% 0% £1,200 £1,800
17/18 75% 25% £1,450 £1,550
18/19 50% 50% £1,700 £1,300
19/20 25% 75% £1,950 £1,050
20/21 0% 100% £2,200 £800
Example on rental income of £10,000, mortgage of £5,000 and costs of £2,000. Source: The Mortgage Works 

Capital gains tax

When you come to sell your buy-to-let property, there will be capital gains tax to pay on any profit. 

It applies to any property which is not your main home, known as your Principal Private Residence. This gets a special exemption.

On property sales CGT is levied at 18 per cent or 28 per cent depending on whether people are basic rate or higher rate taxpayers.

However, gains are added to income to deliver a total amount that decides this. This means that in practice most landlords making decent profits should pay the 28 per cent rate.

If you only have one property and it is considered your principal home, then you do not have to pay CGT, however, the taxman may want evidence that you were actually living there.  

There are two reliefs you can get on your CGT bill, but they are both less generous than they once were.

Landlords who used to live in their rental properties saw certain reliefs taken away this year

Landlords who used to live in their rental properties saw certain reliefs taken away this year

Private residence relief   

Along with the scrapping of mortgage interest tax relief, a new capital gains tax regime has been brought in for ‘accidental’ landlords.

These are landlords who once lived in a property before going on to let it out.  

If a landlord rents out a property that was once their main home, capital gains tax only applies on the amount the home went up in value while they weren’t living there.

Previously landlords could also add an extra 18 months onto the amount of time they lived at the property – this is known as the ‘final period exemption’.

But as of this tax year that has now been reduced to nine months.

As an example of how this works, under the old rules a landlord who has owned their property for 10 years and lived in it for two would only be taxed on six-and-a-half years of capital gains – the 10 year period minus the two years of residency and the added 18 months’ relief.

But now they’ll be taxed on seven years and three months of capital gains – the 10 years, minus the two years residency plus the reduced nine months’ relief.    

Lettings relief 

‘Lettings relief’ has also been rolled back this year.

Previously, when a landlord sold their former home after renting it out, up to £40,000 of their gain can be exempted from capital gains tax.

Couples could benefit from an exemption of up to £80,000.

Under the new rules however only landlords who live in the property with their tenants now qualify for this benefit.

Offsetting stamp duty and estate agent’s fees 

Have a buy-to-let tax question? 

Taxes for landlords have changed dramatically in recent years. This guide is regularly updated to keep you informed on the current rules.

If you have any questions on buy-to-let tax that you can’t find answered here, get in touch at editor@thisismoney.co.uk

You can reduce your CGT bill by deducting some of the expenses associated with buying and managing a property.

You can offset costs such as the stamp duty paid when you purchased the property as well as solicitors’ fees, estate agent’s fees to market the property, and surveyors’ fees if a survey was carried out when you purchased the property.

You may also be able to offset losses on other property against your capital gains tax bill.

Inheritance tax

When you die any buy-to-lets will form part of your estate.

There may be a tax charge to pay of 40 per cent if the total estate exceeds £325,000 or £650,000 for married couples.

There are ways to reduce your inheritance tax liability by making gifts to relatives and putting bits of your estate in trust. This is much more complex with a property than it is with cash, shares or funds, which can be passed over in small chunks.

From this year each individual is offered a ‘family home allowance’ of £175,000, so they can pass their home on to their children or grandchildren tax-free after their death. The family home allowance is added to the existing £325,000 Inheritance Tax threshold.

This allowance does not apply to buy-to-let properties. 

Find an independent financial adviser or solicitor to help with reducing your inheritance tax bill.

 

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