Published: 5th April 2018
Becoming a property investor has its own set of unique challenges, but none more so than that of the tax landscape. Tax is one of the biggest headaches for a property investor with any size of portfolio, but it is vital that it is understood fully.
With recent changes to taxes, any landlord who felt that they had a grip on things has been forced to go back to the drawing board. Understanding the taxes that might affect you will help you to forecast the profits you can expect to realise, what investment you should make and the best way to go about it.
In 2017, the Government announced a raft of changes that hit property investors hardest of all. It meant that most had to reconsider how their investments would work, and provided a new list of challenges for anyone wanting to enter the buy-to-let market.
One of the most significant changes that was brought in during April 2017 restricted the tax deductibility of mortgage interest. This has meant that investors can no longer offset their mortgage interest payments against their profits. This is something that is being introduced in yearly stages and will be fully complete by April 2020. For a large number of investors, this reduced their monthly yield considerably and some were forced to increase rents as a result. Whilst some have found that there was a loophole when it came to buying the property through a limited company, this was not a solution that worked for everyone.
April 2017 also saw the introduction of a 3% stamp duty increase on second properties. Whilst some were unaffected by this, others found it made a big difference when considering what property to purchase and what their eventual capital gain would be.
If you offer a fully furnished property, it used to be possible to claim a Wear and Tear Allowance. This has now been replaced with a relief that allows landlords to deduct the cost of replacing furnishings and appliances. This relief is for like-for-like replacements and disposal costs. This will require landlords to keep a record of what they spend, and landlords of unfurnished properties may be encouraged to replace furnishings that they would otherwise have left, thanks to this new policy. This means that landlords can be happy that they are maintaining good standards within their properties and tenants can look forward to a better quality of living.
If a landlord buys property through a limited company, then they used to be able to take £5,000 of dividends tax-free, regardless of their income. However, from April of this year, that will drop to £2,000. Basic rate tax payers earn less than £45,000 and will be subsequently required to pay 7.5% on dividends, whilst higher rate tax payers will be stung for 32.5% on their dividends.
As a landlord, there are a number of different taxes that may affect you. The level of tax that you are required to pay will depend on your income and the profits you make from your property portfolio. It is important that you factor all of these into your business plan before you invest in order to determine how much you should spend and what rent you need to achieve to still make the level of profit you are looking for.
Landlords are required to pay Income Tax on their rental profits at either 20% if you earn less than £45,000, or 40% if you earn above this. Most property investors are likely to fall into the 40% tax bracket as their rental income is likely to sit on top of any other earnings they make.
Stamp duty is calculated based on the price of the property you are purchasing. If you already own a property, such as your own home, you will be subject to an additional 3% of stamp duty as soon as you buy a subsequent property. You will also be expected to pay VAT on any professional fees if you are not VAT registered.
If you have bought a property as a long-term investment, you may need to consider the likelihood of Inheritance Tax. At the moment you receive £325,000 inheritance tax-free which increases to £1 million if you include your main residence. However, if you intend to leave your property portfolio to your loved ones, it is worth remembering that they could be left with a 40% tax on your estate if it exceeds those limits.
Capital Gains Tax is based on the profit you make when you sell your property. The first £11,300 of your profit is tax free, and the tax you are expected to pay on the remaining profit will depend on what rate of tax you pay on your earnings. Basic rate tax payers earn under £45,000 and will be required to pay 18% on their property profits, whilst earners over £45,000 will pay the higher tax rate of 28%.
If you purchased your property through a limited company you will also be expected to pay Corporation Tax on your rental income, as well as the profits from any sale. A limited company purchase means you are also subject to Dividend Tax for any money that you take out of that company.
All of these changes are pertinent to any property investor, and it is important that they are all considered carefully before any investment is made, or when deciding what to borrow. Your property portfolio needs to work for you, and it will only do this if you have a thorough understanding of the tax changes that will impact on it.