Act fast to thwart the taxman and keep your property profits
With the end of the tax year approaching rapidly, now’s the time to get all your paperwork together when calculating the buy-to-let tax you owe. In this article, we’ll look at the buy-to-let tax rules and how to make sure you’re minimising the tax you pay on the best property investment opportunities.
Make sure you tell HMRC you’ve got rental income
The first thing to note is that if you’re renting out a property, you must tell HMRC. If you don’t, you could be charged a penalty. It might be that you owe tax from previous years – if you think you might, then tell HMRC directly. The taxman might be a bit of a villain in many people’s eyes, but if you’re honest with them, they might treat you a little more fairly.
What tax does a buy-to-let property investor pay?
When you let out a property, your profit is treated as income. The tax you pay will be income tax. How much you pay depends upon your total taxable income. If you pay income tax at the basic rate, then you’ll pay 20%. A higher rate taxpayer will pay 40%, and an additional rate taxpayer will pay 45%.
There may be other income tax reliefs that you can claim to reduce the tax you pay. For example, on pension contributions or maintenance payments.
Mostly, though, it’s the costs of investment property ownership that will help to slash your buy-to-let tax bill.
Get your paperwork together
The government has attacked buy-to-let property investment over the last year or two. It’s been a populist move which, in my view, is very short-sighted. The tax rules that are changing include:
- Wear and tear costs are now limited to replacement costs
- A stamp duty surcharge of 3% is now levied on investment property purchases above £40,000
- Mortgage interest tax relief is being reduced to basic rate by 2020
However, there are still plenty of costs that you can deduct from your rental income to reduce your tax liability. These allowable expenses include:
Property management fees
Maintenance and repairs made
Utility bills and service charges (if paid by you)
Council tax bills (if paid by you)
Service fees such as gardening and cleaning
Direct costs including stationary, phone bills, advertising, in connection with the property
Here’s a tip that will help you keep track of these costs. If you haven’t done so already, open a separate bank account for your investment property income and expenditure. It will stop any confusion between your rental income and other income and daily costs. You’ll find it much easier to figure out your profit. And you’ll be able to see at a glance the paperwork you need to collect together.
The taxman may want to see proof of all your costs, so keep every receipt you can. Paying by card is better than paying by cash – you have an immediate audit trail of your spending.
Now that you’ve got your expenses together, all you need do is deduct these from your rental income to calculate your net rental income. It’s this income on which you’ll be tax liable.
Beware, though, that this is the last year you’ll be able to calculate your income tax liability so easily. From April 6th 2017, the amount of tax relief you can claim on mortgage interest is changing.
How mortgage interest tax relief is changing this year
Over the next four years, the ability for higher rate and additional rate taxpayers to claim full tax relief on their mortgage interest payments is being phased out:
- Next year (for tax year 2017/18), 75% of interest rate payments can be offset by the highest rate of income tax you pay. The other 25% will be limited to tax relief at the basic rate.
- In 2018/19, 50% of the mortgage interest payments will be limited to tax relief at the basic rate.
- In 2019/20, you’ll only be able to claim higher rate tax relief on 25% of the mortgage payments. The other 75% will be limited to the basic rate.
- From 2020/21, all buy-to-let mortgage payments will be limited to tax relief at the basic rate.
How will the mortgage interest tax changes affect you in the future?
Let’s use a simple example. Let’s assume you own an investment property and collect £12,000 rent per year. Your mortgage payments are £8,000 per year. This year:
If you’re a basic rate taxpayer, you’ll pay 20% income tax on the £4,000 profit. That’s £800.
If you’re a higher rate taxpayer, you’ll pay 40% income tax on the £4,000 profit. That’s £1,600.
You’ll pay income tax on the net rental income (before mortgage interest is deducted). Then you will be given a credit at basic rate tax on the mortgage interest payments. It means:
A basic rate taxpayer will be liable to 20% income tax on £12,000, and then have 20% x £8,000 deducted from this liability to arrive at a tax bill of £800 (£2,400 – £1,600).
A higher rate taxpayer will be liable to 40% income tax on £12,000, and then have 20% x £8,000 deducted from this liability to arrive at a tax bill of £3,200 (£4,800 – £1,600)
As you can see, if you’re a higher rate taxpayer, by 2020/21 the government is going to be grabbing more of your rental profits.
How can you slash your buy-to-let tax bill?
This year, get all your paperwork together early. Make sure everything is in order, and the I’s are dotted and the T’s crossed. If you’re unsure about filling in your self assessment, get an accountant to do it for you (remember, you can deduct the cost of accountancy from your rental income to reduce your tax bill).
If you’ve made a loss on your buy-to-let investment property, you can offset this against future profits by carrying over to next year. If you own more than one property, you can offset losses from one property against the profits from other properties.
If you’re submitting your self assessment online, you’ll have until 31st January 2018 to do so. Get it done as early as possible. Then it’s done and dusted, and you can get on with making money from your property investments.
The time to act is now!
If you’re a higher rate taxpayer, as you can see from the above example, you could find yourself paying a lot more in tax. There are plenty of ways you can slash this liability. For example, if you’re married and you hold your property in your sole name, it might be advantageous to transfer the investment to your spouse if he or she is a basic rate taxpayer.
Many property investors are switching their portfolios to a limited company structure. They get to treat mortgage interest payments as a business cost. It might be a direction for your property investments.
Others are setting up partnerships for tax purposes.
Here’s the thing: you know that the tax rules are changing. There are ways in which you might be able to reduce your tax liability. Which is best for you depends on a whole range of factors, including:
- Your tax position
- How many properties you own
- Your marital status
- Your income
- Your rental income
- Your investment objectives
Contact one of our team today on +44 (0)207 923 6100, and we’ll be pleased to discuss your options further. Our objective is to help you achieve your objectives.
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