Tax guide for buy-to-let investors
Introduction
Investing in buy-to-let continues to be a very popular form of investment for many people. This purpose of this guide is to help inform your investment decisions by giving an overview of the tax factors involved.
Ownership structure
For new property purchases, it's important to consider whether to purchase the property as an individual, as joint owner or via a partnership (often with a spouse) or via a limited company. There are significant differences in the tax you'll pay. The optimal ownership structure depends on:
- How many properties you intend to purchase in the future.
- Whether, and when, you intend to sell the property.
In this guide we explain the tax aspects for owning your property as an individual / joint individuals and for owning via a limited company. Our complementary guide to property tax structuring provides further advice about how to optimise your ownership structure from a tax perspective.
Tax due on buying the property
Stamp Duty Land Tax (SDLT) is payable when you buy a property in England. Buy-to-let properties have a higher rate of SDLT compared to buying your home, meaning that you pay 3% on the first £125,000; 5% between £125,001 and £250,000; 8% between £250,001 and £925,000; 13% between £925,000 and £1.5m; 15% on any remaining purchase price above £1.5m.
If you buy via a limited company, and pay more than £500,000, you're may also be subject to the Annual Tax on Enveloped Dwellings (ATED). Most buy-to-let investors will be exempt from this additional tax provided they are letting the property to non family members.
Tax due on rental income
Whatever your ownership structure, tax will be due on the profit you make from letting it. In calculating this profit you can include the cost of repairs and maintenance (including service charges), marketing (such as estate agents fees) and reasonable expenses relating to your management of the business (such as home office costs, travel to inspect the property).
The costs of financing the property (e.g. your mortgage interest and any upfront fees) are treated differently depending on your ownership structure. How you are taxed on the resulting profit also depends on your ownership structure.
Owning the property as an individual (or joint ownership)
You pay income tax on the net rental income (after the most allowable expenses but before mortgage interest and other finance costs). This will be at 20%, 40% or 45% depending on your overall income level. You'll then be entitled to deduct 20% of your mortgage interest and other finance costs to reduce your tax bill.
Note that it's the profit you make before mortgage interest that counts towards your total income for tax purposes. So if you're a high earner this can contribute to loss of personal allowance (meaning your rental income is taxed at an effective rate of 60%) and tapering of your annual allowance for pension contributions.
Things are further complicated by the fact that previously your mortgage interest was treated as an allowable expense, and we're currently in a four year transitional period between the two different treatments (so in 2018/19 half of your finance costs will be under the old rules, and half under the new rules).
Owning the property via a limited company
For a limited company, mortgage interest and finance costs are fully allowable as a business expense. You then pay corporation tax at 19% on the net profit.
However, further tax is payable if you need to extract that profit from the company. There are different ways to do this and we recommend you seek professional advice from your accountant to plan the best approach for your individual circumstances. However, assuming you have other sources of income, it's usually best to do this via a dividend payment.
So for the purposes of this guide we'll assume this applies to you. You're entitled to an annual tax free allowance of £2,000 for dividend income (in addition to your personal allowance). You pay Income Tax on the remaining dividend at 7.5% (basic rate), 32.5% (higher rate) or 38.5% (additional rate) depending on your total income.
One of the main advantages of owning the property via a limited company is that you can choose when you extract profit from the business. This is important if you don't need the money to live off:
- If you're planning to build a larger property portfolio then you can recycle profits within the company, having only paid 19% corporation tax. By contrast, most individuals will have paid 40% Income Tax. The tax saving leaves more cash available for reinvestment and helps you build your portfolio more quickly.
- If you can wait until retirement, you can accumulate profit within the company and only begin drawing it via dividends when you need it to help fund your retirement. This may result in significant savings in the rate at which you pay Income Tax.
Tax due on selling of the property
Since property generally increases in value, the tax you'll pay on the gain you make if / when you sell the property should be an important factor in your tax planning. The gain is calculated based on your selling price less the original purchase price and any expenditure you've made improving the property. Amounts spent on repairs and maintenance are not included (but are an allowable expense against your rental income). How the gain is taxed, and how much you'll pay, depends on your ownership structure.
Properties owned as an individual or joint owner
You (and any other joint owners) will each pay Capital Gains Tax on the gain, which you disclose and pay via your self assessment tax returns. You each have an annual tax free allowance of £11,700, after which tax will be paid at 18% or 28% depending on your total taxable income.
If you've lived in the property as your main residence then you may be entitled to further tax reliefs:
- Principle Residence Relief - you only pay Capital Gains Tax on the proportion of the gain that relates to the period it was let. You also get relief for the last 18 months you owned the property even if it was let in that period. For example, assume you owned a property for 12 years, lived in it for the first 6 years and let it for the remaining six years before selling. Let's also assume you made a gain of £250,000 on the sale. You won't pay capital gains tax on the first 6 years, or the last 18 months. So the gain will be reduced to £93,750 (£250,000 / 144 months of a ownership * 54 months subject to CGT).
- Letting Relief - you can get the lower of the amount you got in Private Residence Relief, the chargeable gain you made from letting your home (excluding periods it was empty), or £40,000. Continuing the above example, letting relief would be the lower of £156,250 (the gain you saved via Private Residence Relief), £93,750 (assuming no void periods where it was unlet) and £40,000. So you'd be entitled to a further £40,000 of relief reducing the taxable gain to £53,750.
Properties owned via a limited company
If you own the property via a company, the company will pay corporation tax on any capital gains at 19%, and shareholders will pay Income Tax when they take the money made out of the company. For example if you take the money out by way of dividend you'll pay income tax at 7.5%, 32.5% or 38.1% depending on your total income in the tax year.
There is no annual allowance, but companies benefit from an "indexation allowance", which uplifts the original cost of the property (and any improvements) by the increase in Retail Price Index (RPI) during the period between incurring the cost and December 2017 - reducing the amount on which you pay corporation tax. Unfortunately this "indexation allowance" was removed starting 2018, meaning that purchases after this don't benefit at all and that purchased before 2018 have the effect "frozen" at the RPI level as at December 2017.
There is no entitlement to Principle Residence Relief or Letting Relief for companies. Although if you did live in the property before letting it, you will have benefited from these reliefs when transferring the property to your limited company.