Buy-to-let taxes can be complex and difficult to understand, particularly when they are ever changing. However, it’s paramount that landlords investing in property understand their tax obligations before renting out their properties.
In this guide, we offer a comprehensive overview of the tax implications that come with owning a rental property. With tips on how to save money and ways in which you can best prepare, our goal is to help you invest in the smoothest way possible.
If you’d like further information, BuyAssociation can put you in touch with leading financial advisors and mortgage brokers that can help you find your feet in the rental market.
The tax on buy-to-let properties you should expect to pay
All buy-to-let landlords are liable to pay tax on any property rented to tenants. Taxes on buy-to-let properties differ according to whether the property is situated in England, Northern Ireland, Scotland, or Wales. However, each type of tax will deal with a different aspect of the residential property.
The three main forms of taxation in the UK:
- Income tax
- National Insurance
Like everybody else employed within the UK, these types of tax apply to landlords too.
In addition, upon selling your rental property, you may also have to pay capital gains tax. Stamp duty is also payable on all buy-to-let properties, the amount of which is determined by the price of the property. You are responsible for paying council tax if the property is unoccupied, but your tenant is liable if it is occupied – unless you opt to take this responsibility on yourself.
Income tax on rental property
Personally owned property tax. This type of tax is straightforward and can be easily calculated. Landlords would first deduct allowable expenses from the rental income to work out profit. From there, income tax would be paid at a rate dependent on your income and the tax bracket you fall under.
The basic rate taxpayer will pay 20% tax, whereas the higher rate taxpayers will have to pay more tax due to the 40% charge imposed on them. The standard Personal Allowance is currently £12,570, this is the amount of income you don’t pay tax on. To find out which tax band you fall into, you can refer to the Government website for a run down.
When completing your Self Assessment tax return, you have to declare any rent you receive from your properties.
BTL and corporation tax. The properties owned by limited companies are subject to different taxes. Many property investors are beginning to see the advantages of buying through a limited company due to the flexibility of buy-to-let (BTL) tax.
All mortgage interest payments are tax deductible, contributing to a lower tax bill. Instead of paying income tax on the profits, you pay corporation tax. There is no further tax due if the profits are kept within the company (perhaps to fund another property).
Profits can be paid out of your company in three ways: salaries, dividends, and pension payments – each has its own tax implications.
Buy-to-let stamp duty tax
Stamp duty is payable on all property purchases, excluding first-time buyers that purchase a home that is valued under £300,000. However, for all other properties, stamp duty is charged in bands.
If you’re looking to buy a BTL property or even a second home in the UK, you will be subject to paying a stamp duty surcharge.
No matter your reason for purchasing a second property(whether that be for rental purposes, a holiday home or simply a second residence for yourself), stamp duty cannot be avoided.
How much stamp duty do you pay on a second property?
The stamp duty charged on a second home is based on a tiered system and correlates with the property price itself.
- 3% on the first £125,000
- 5% up to £250,000
- 8% up to £925,000
- 13% up to £1.5 million
- 15% on anything over
Mobile homes and houseboats are also exempt from stamp duty – no matter how much the value of it may be.
Despite the expenses incurred and the rising percentage of stamp duty on high value properties, buy-to-let stamp duty can be deducted from capital gains. This means that landlords won’t have to pay the tax twice.
Capital gains tax
You are responsible for paying capital gains tax (CGT) if you sell your rental property after it has appreciated in value while you owned it. CGT is only payable on second homes and buy-to-let properties.
Put simply, if you are making profit from the sale of a house once legal fees and stamp duty are deducted, you will have to pay the tax on that income.
You will only have to pay capital gains on income that is over your tax-free allowance. This allowance is £12,300. Anything earnt above this will be subject to tax depending on your tax band.
Taxpayers who are taxed at the basic rate are charged 18% CGT, while those taxed at the higher rate are charged 28%.
As stated, for tax year 2022/23, the CGT tax-free allowance means landlords can earn up to £12,300 tax free. For couples selling a property, this figure could be doubled, allowing them to earn £24,600 without paying tax.
How can capital gains tax be reduced?
It is possible to pay more tax than necessary after the sale of a house. Therefore, to get the most accurate sum, you should be aware of the ways in which you can reduce your bill.
The total amount of tax payable on the capital gain earned can be reduced after deducting some costs. The following costs can be deducted from your gain:
- Solicitor and estate agent fees
- Stamp duty paid at the time of purchase
- Any costs incurred upon improving the property (for example, an extension to the house).
- Advertising and promotional costs paid to sell the property
- Survey and valuation costs
The tax rules for furnished holiday lets
The tax implications for furnished holiday lets differ from the standard buy-to-let (BTL) property. The main reason for this is the nature of the letting – this category of renting falls under trading businesses.
Many property investors choose to acquire holiday lets due to the tax advantages associated with them. However, there is a strict criteria that must be met before the rental property can be classified as a furnished holiday let (FHL).
Once your property meets this criteria, investors can benefit from specific tax rules.
Income tax on holiday lets
The profit that is liable for taxation on a holiday let is calculated the same way that other commercial buildings are. This means that you pay income tax on the rental payments you receive within the tax year, minus the allowable expenses.
The tax-deductible allowable expenses include a larger list as opposed to standard buy-to-let properties, due to the increased risk and higher operating costs associated with holiday lets. Some of the costs you can claim include:
- Repairs and maintenance
- Mortgage interest
- Heating and electric for lighting and power
- Water payments
- Welcome packs
- Gas safety checks
You may also be able to claim capital allowances on any fixtures on the property purchase. This can include carpets, hot tubs, sofas and wardrobes – often in excess of 20% of the cost of the property.
Small business rate relief for council tax
A holiday rental that is available to let for 140 or more days in a year will qualify for holiday let business rates. These business rates are a tax that helps to pay for local services.
Holiday lets are also classed as self-catering properties, meaning that they are subject to business rate property tax. However, holiday let landlords can qualify for small business rate relief – a relief that reduces council tax payments.
How can landlords reduce the tax on a buy-to-let property?
In recent years, there have been numerous changes imposed by the Government that impact buy-to-let landlords. Rising tax rates on income and increasing interest rates on buy-to-let mortgages are leaving many landlords searching for ways to maximise profits and save money.
There are several ways in which BTL investors can save money:
1. Transferring your property portfolio to a limited company
It can be more tax efficient to own your property in a company structure than in a personal capacity. Your property is basically sold to a company in which you are a director and have a controlling interest. Even though there are still obstacles to overcome, doing so offers benefits in terms of capital gains and income taxes.
To comply with stamp duty land tax, properties must be sold at market value to your company. Approval from the lender is also required for remortgaging a property. However, dividends can be beneficial in the long run.
2. Claiming allowable expenses against pre-tax profits
After deductions for ‘allowable expenses’, landlords must pay taxes on the profit from renting out their property. Deducting allowable expenses will reduce the amount of tax you have to pay.
Allowable expenses include:
- Legal fees: For a lease lasting more than one year, you can’t claim legal fees associated with the sale of the property or any initial lease fees. Legal fees that are related to the renewal of a lease, short-term tenancies, evictions, rent collection, or management fees, as well as accountancy, are all claimable.
- Utility bills: These should be claimed if there are any service charges or other fees involved with renting the property – for example, electricity in common areas. In a furnished holiday rental property, you may be expected to pay for electricity, gas, water, TV licence, telephone, and other services.
- Necessary property repairs and maintenance that may be required: Unless the work is a capital improvement, repair work done on the property can be claimed. You can’t claim repair costs carried out on a property prior to letting it if you previously lived in it. Maintenance completed before letting a property is considered maintenance for private use, not rental use, so it cannot be claimed.
Other costs you can offset include:
- Estate agent fees
- Fees for accountants
- Buildings insurance
- Property loans interests
- Council tax
- Ground rent and service charges
How BuyAssociation and our partners can help you invest in property without hassle
BuyAssociation is a leading property investment company based in Manchester. Our goal is to help landlords expand their property portfolios with lucrative properties.
We are passionate about helping you maximise your earnings by identifying property investment opportunities that will provide you with the best possible returns on your investment. Our team of experts has extensive experience in the property sector and are able to advise you on what type of property would be most beneficial to you.
For financial assistance, we can refer you to recommended tax experts and accountants. By working with us, we will help you in your venture towards building a successful portfolio.