Planning to take advantage of low interest rates?
After a challenging year for the UK’s residential landlords, you might have read about improvements to the buy-to-let mortgage market in recent weeks.
In the three months to 31 May 2021, the average interest rates for residential landlords had declined. A two year fixed rate buy-to-let mortgage fell 0.10 percentage points to 2.95%, while a five year fixed dropped 0.11 percentage points to 3.30%.
For higher loan to value (LTV) ratios, the drop was even more significant. As you would expect, it is vice versa for lower LTV. This may partly be down to increased competition.
By April 2021, there were 2,333 buy-to-let mortgage products on offer – more than at any point since the onset of the pandemic.
It all adds up to good news for investors seeking to expand their property portfolio or buy a second home. This is further enhanced by the fact rental incomes grew 5.9% in April. It’s the fastest growth since January 2015.
If these favourable borrowing conditions appeal to you, consider buying a holiday home or additional rental properties. In this case, effective tax planning for landlords becomes essential. To help you, here’s a useful overview of the tax landscape. We will also discuss how you can best manage your tax obligations.
Taxes have significantly shifted for landlords over the past five years. It’s not as attractive as it once was to borrow money to fund your purchase.
However, by talking to us you can make sure you are set up in the most efficient way to enjoy your rental income and any capital gains.
Stamp Duty Land Tax Taper
Let’s start with a note on the stamp duty land tax holiday. The temporary £500,000 tax free threshold in England and Northern Ireland no longer applies.
Until 30 September 2021, no stamp duty will be paid on the first £250,000 of residential purchases in England and Northern Ireland. Landlords and second home buyers can benefit from this, albeit with a 3% surcharge.
To qualify, you must complete the deal before the end of September. If you are just starting out, you should still benefit. However, ensure you have everything prepared and that the process runs smoothly.
Tax liabilities on rental income
You probably know about your rental income tax obligations if you are an experienced landlord. However, many landlords overlook the importance of tax planning for landlords, which can significantly impact their overall financial health.
Rental income is subject to income tax. It is added on to any other taxable income and taxed at the relevant rate.
Rental income includes rent, non-refundable deposits, additional costs (such as charges for the cleaning of communal areas in flats) and any refundable deposit you retain. Understanding tax mitigation strategies can help you minimise your tax liabilities and retain more of your rental income.
Everyone has a personal allowance of £12,570 in 2021/22. For those whose gross property income is less than £1,000, the property allowance (an extra £1,000 tax exemption).
Rental income which does not see you exceed these limits is not taxable, assuming you have no other source of taxable income, but you might still need to make a declaration.
Generally speaking, after that your tranche of rental profits falling between:
£12,571 and £50,270 is taxed at 20%;
£50,271 and £150,000 is taxed at 40%;
above £150,000 is taxed at 45%.
If you are married, as with other assets, it can be worth exploring holding properties in your spouse’s name if they are in a lower income tax bracket to you.
Income tax deductions
You can deduct certain costs from your rental income associated with your day to day expenses.
These include a range of expenditures from letting agent’s and accountant’s fees, to property maintenance and repair (although not improvement works).
The big change in recent years concerns the rules for buy-to-let mortgage repayments. Prior to 2017, the interest component of these was classed as a deductible expense, often representing a significant saving on income tax.
However, the Government brought in new rules to end this. Between 2017 and 2020, there was a phased regime but mortgage interest payments are no longer deductible.
Instead, 20% tax relief can be claimed on your interest payments, subject to certain limits. This is neutral if you pay tax at 20%.
However, if you pay tax at a higher rate it could add a significant cost burden to you and change the dynamics of investing in rental property.
Bear in mind that if you extend your property portfolio now, taking advantage of lower interest rates, it might push you into a higher tax bracket.
Property companies
One potential mitigation is to hold your investments in a limited company. This strategy highlights the importance of tax planning for landlords, as it allows rental income to be taxed like any business income.
For example, in addition to the company paying corporation tax, you will probably face personal tax liabilities when withdrawing the money from the company.
It is very important to go into such an arrangement fully aware of the implications. We can help you understand the pros and cons.
Capital Gains Tax considerations
Capital gains tax is a tax levied on any gain you make when you dispose of assets that have gone up in value.
Like income tax, the rate you pay depends on the tax brackets that you are in. For residential property, these are:
• 18% of the gain within the basic-rate band;
• 28% of the gain within the higher and additional rate bands*.
*Uniquely, these are higher capital gains tax rates than for most other asset classes, where the rates are 10% and 20% respectively.
Your primary residence is generally exempt from capital gains tax. However, this automatic protection does not apply to additional properties you own.
It is important to emphasise that capital gains tax is only paid on the profit made on an asset, not the sale price.
You can deduct specific costs and offset losses from other assets against gains from previous years. Additionally, everyone enjoys an annual capital gains tax exemption, currently protecting the first £12,300 of gains. You can combine this exemption with that of a spouse for joint assets, allowing for a total protection of £24,600 each year.
Letting relief can reduce the capital gains tax you may pay on a property. However, this is only applicable to people who let out part or all of their own home while residing in it.
Specifically this tax relief is not available to buy-to-let investors who let out property having never lived in it.
Various factors go into working out letting relief. Overall it is capped at £40,000, or £80,000 for married couples.
Holiday lets
If you are interested in taking advantage of low interest rates to buy a holiday home, these come with their own unique tax rules which can be advantageous.
To qualify as a holiday let, strict criteria must be met. These criteria include how often the property is available for hire each year, who stays in it and the occupancy rate.
If these are met, there are a range of capital gains and income tax allowances that become available.
Optimise your position
If you find the current low borrowing rates attractive, consider buying another property. In this situation, effective tax planning for landlords is crucial. Before making any decisions, talk to us first. We can help you maximise your returns.
The tax rules might have tightened but we can optimise your returns by compliantly using the appropriate tax allowances.
Get in touch for proactive tax planning advice on 0161 761 5231 or email theteam@horsfield-smith.co.uk.
