Below Ian and Arthur provide an insight into the common tax issues faced by buy-to-let investors.
Property Tax Liabilities for buy-to-let Investors
Arthur Weller, co author of 27 proven property tax saving strategies, explains the common tax liabilities facing buy-to-let investors.
Income TaxThis tax is due on an annual basis. The tax liability is calculated by offsetting the property related expenses against the rental income. Tax is then charged o the net rental income profit.
Capital Gains TaxThis tax is liable when a property is sold at a higher price that what it was purchased for, or when a property or part of a property is transferred to a non-spouse.
The capital gain is calculated by deducting the allowable costs and Inland Revenue tax relief’s, from the selling price of the property.
Examples of allowable costs include, property extensions, purchasing related costs etc.
Stamp DutyThis tax is liable when, land or residential property is purchased where the purchase price is above £60,000, or where it is transferred and the outstanding mortgage amount is greater than £60,000
The rates of stamp duty vary between 1% for properties less than £250,000 and 4% for properties over £500,000.
It is also worth noting that there are certain areas that are exempt from stamp duty, where the property is purchased for less than £150,000. A comprehensive list of such areas is available from the Inland revenue website.
Inheritance TaxInheritance Tax is commonly referred to as a ‘gift tax’ or ‘death tax’.
If at the time of your death you pass on part or the whole of your estate then again the inheritor could be liable to pay Inheritance Tax.
There is currently an IHT threshold level of £263,000 for the 2004-2005 tax year. Anything above this amount is taxed at 40% i.e. at the highest rate.
This means that if at the time of death, your whole estate is valued at less than £263,000 then the inheritor will have no tax to pay.
B) Cutting your capital gains tax (CGT) Bill
Given the property boom over recent years, most investors fail to realise that selling their property could well lead to a hefty tax bill of upto 40% on the net profit of the profit.
This means that of a £100,000 capital gain on a profit, the £40,000 could go straight to the Inland Revenue.
Arthur Weller explains two methods available for minimising and even wiping out such a gain:
Private Residence ReliefThis relief is available to you if you have lived in a property that has been classed as your main residence.
If the property has been your main residence throughout your period of ownership, then you can claim full residence relief. This means is that you will have no tax liability when you sell the property.
However, property investors, more commonly use, the partial residence relief. This relief can be claimed if you used the property as your main residence, but then also moved out of the property whilst still retaining ownership i.e. the property was rented out.
In such a scenario, no capital gains tax will be liable for the duration that the property was the main residence and for the last three years of ownership. The latter is covered by the ’36 Month Rule’.
A growing number of property investors are using the ’36 Month Rule’ to their advantage. When a new property is purchased, they are renting out the existing property and moving into the new one, thus allowing for another three years of tax free capital growth.
Joint ownership of property between husband and wife
Also, holding a property in such a way is also beneficial if one is a lower rate taxpayer than the other. In this case it may be beneficial to hold a greater share of the property in the name of the lower-rate tax payer.
This will help to not only reduce the capital gains tax bill when the property is sold, but also any ongoing income tax liabilities.
It is also worth noting that properties can be transferred between husband and wife freely without triggering a CGT liability. This means that some smart tax planning can lead to a greatly reduced tax bill.
C - Using Ltd Companies for property investment
One of the most commonly asked tax questions is whether holding properties in a limited company will save property tax.
Ian McTernan, author of How to use companies to cut your property tax bills, lists the significant advantages and disadvantages of holding your properties in a Limited company.
a) The first £10,000 that a company makes is exempt from tax.
You will not have to pay any Company tax on profit that is equal to or below this threshold level if the money is retained within the company.
b) Lower rate tax saving
As a higher rate taxpayer, you pay 40% on your profit and gains. For a limited company the tax rates are between 0% and 30% - a considerable saving.
c) Stamp Duty Savings
You only pay stamp duty at a rate of 0.5% when purchasing company shares.
Other benefits include:
- A company can define its own accounting period that does not exceed 18 months.
- You only pay stamp duty at 0.5% when purchasing company shares.
- Indexation relief is still available for any capital gains.
- Lower tax rates, as companies pay tax between 0% and 30%.
- The first £10,000 a company makes is tax-free if the profits are retained within the company.
- Properties can be transferred within companies without incurring a tax liability.
- You can grow a portfolio quicker within a company by continuing to re-invest the profits and thus deferring any tax.
- Dividends can be extracted from a company in a tax efficient way. Drawbacks
- Companies cannot use the annual personal CGT allowance. This allowance is £7,900 for the tax year 2003-2004.
- Official company accounts must be produced. The cost of drawing up such accounts can be 3-4 times more expensive than having your sole-trader accounts drawn up.
- Banks are less reluctant to lend money to you if you are purchasing through a company.
Ian is also a specialist in dealing with Inland Revenue tax investigations, and below gives an insight into how the revenue finds those avoiding tax.
About Arthur Weller
Arthur Weller is a Chartered Tax Advisor (CTA) and an integral part of the Property Tax Portal team. He offers a special rate tax advisory service on any aspect of UK taxation, including property taxation, for as little as £87 for a 30 minute telephone tax consultation.
To learn more about this service click here.