How investors remortgage and grow portfolios safely
By using a remortgaging strategy to buy a residential investment property, investors could be rewarded by several tax benefits. These include:
- Releasing capital gains without paying capital gains tax, enabling faster portfolio growth
- Reducing income tax bills by using mortgage tax relief
- Limiting inheritance tax liability in the future by gifting remortgaged equity
However, if investors don’t construct an effective remortgaging strategy when buying an investment property, all your good work could be undone. Here, we’ll discuss the tax trap that poorly planned remortgaging could cause. You’ll also learn an easy way to make sure you don’t put your portfolio and lifestyle at risk when you remortgage.
A reminder of how capital gains tax is charged on investment property
When you sell an investment property, the capital gains tax (CGT) liability is calculated as:
(Sale price – purchase price) x CGT rate
The CGT rate depends on your tax position. If you pay income tax at the basic rate or lower, you will pay CGT at the rate of 18%. A higher rate taxpayer is liable to CGT at 28%.
Notice that it is the purchase price which is used as the reference for CGT calculation and not the amount of your mortgage.
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Let’s say that you bought an investment property for £50,000 with the aid of a £35,000 mortgage. Over the years, its value has increased to £300,000. You’ve used this valuation increase to release equity and invest in other properties. In total, you now have mortgages totalling £240,000.
You now find that you want to sell the property. Its yield is not as good as other property investment opportunities. You also expect its capital growth to underperform.
Before you sell the property, you calculate what CGT you must pay. You’re a higher rate taxpayer and have already used your CGT allowance.
(£300,000 – £50,000) x 28% = £70,000
Now, should investors sell the property and receive the valuation of £300,000, you will realise £60,000 profit after you have paid the mortgage of £240,000. However, on the sale of the property, investors will owe the taxman £70,000 in capital gains tax. Selling the property will cost you £10,000!
It is the remortgage trap. The above example should be a warning to all property investors – when you remortgage, make sure you plan your strategy properly. You could be left with a property that you need to sell, but can’t afford to.
Fortunately, there is a simple method to avoid remortgaging poorly. We’ll look at this in a few moments. First, though, what can you do if you find yourself in the remortgage trap?
How to get out of your remortgage trap
If you find yourself in a remortgage trap, you may be able to escape. But it will take some radical action:
· Don't sell
Your first choice is not to sell. Keep your property until you die. You’ll pass it on to your loved ones, and it will be subject to inheritance tax. If you’ve got a multi-property portfolio, this could save you a significant sum.
Let’s say you own investment property with a value of £5,000,000. You’ve often remortgaged to give away the proceeds or reinvest. The actual purchase cost of the properties in your portfolio is £1,200,000. The mortgages on them now total £4,000,000. You’re a higher rate taxpayer.
Were you to sell the entire portfolio, andyou would incur a CGT charge of £1,064,000. Your total gross proceeds would be £1,000,000. To sell would cost you £64,000!
If you didn’t sell, and all things remained equal, your estate would be liable to inheritance tax (IHT). It is charged at 40%, but you get an IHT allowance of £325,000. The IHT bill will be:
((Sale value – debt) – £325,000) x 40%
= ((£5,000,000 – £4,000,000) – £325,000) x 40%
= £675,000 x 40%
Instead of costing you £64,000, your property portfolio will pay your beneficiaries a net £730,000.
· Speak to a tax specialist
There could be other options open to you. For example, you may be able to transfer some of your investment to your spouse. It doesn’t incur a capital gains tax bill, and when you sell, you can use both your capital gains tax allowances.
You may also be able to spread your sales over two or more tax years. If you have shared the investment with your spouse, this will quadruple capital gains tax allowances available to you.
If you have cash in the bank or can afford not to take the income from your investment property rentals, you could pay down some of the mortgages.
If you do find yourself in the remortgage trap before you sell any of your investment properties you should speak to a tax specialist.
How to avoid the remortgage trap
Like any investment strategy, you should take precautions to reduce the risks. For example:
- When you buy property, you’ll do your research to ensure you buy in the best places to invest in property UK.
- Before you sign on the dotted line, you’ll conduct due diligence and calculate your cash flow projections.
- You’ll use a buy-to-let mortgage broker to get the best financing deal.
- You’ll employ an investment property manager to manage your property.
- A comprehensive tenant vetting process will reduce the risk of getting nightmare tenants.
Why wouldn’t you use a tried and tested strategy to de-risk your remortgaging?
Keeping within safe boundaries of borrowing
While each property and each portfolio is different and can bear different levels of remortgaging, there is a rule of thumb that should make sure you don’t fall into the remortgage trap. Here it is:
- For investment properties bought less than three years ago, only borrow the purchase price plus 60% of the increase in value without borrowing more than 75% of value. So, if you own a property for which you paid £100,000 and is now worth £150,000, you could remortgage to £112,500. If the property had cost £50,000 and is now worth £150,000, you could remortgage to £111,000.
- For properties held more than three years, add another 2% of the increase in value per year without borrowing more than 75% of the property’s value.
Staying within these guidelines should ensure you will always be able to satisfy a CGT bill on the sale of a property. However, I would strongly recommend that you discuss your strategy with property experts before moving forward.
Maximising the benefits of remortgaging
Remortgaging could help you to build your property portfolio very quickly. It releases equity from current properties without paying capital gains tax. It can be used as a deposit on the residential property investment opportunities.
When used for reinvestment, it is possible to apply for mortgage interest tax relief, thus reducing your income tax bill.
You can also use a remortgaging strategy to reduce an IHT liability.
However, to obtain all these benefits you will need to employ a good remortgaging strategy. If you don’t do this, you could find yourself in a remortgage trap and locked into a property that you can’t afford to sell.
Contact one of our team today on +44 (0)207 923 6100. We’ll help you identify the best places to invest in property UK. And we’ll help you to build a strategy to grow your UK property portfolio, maximise income, and reduce tax – today and tomorrow.
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