Tax Questions: Buy-to-let Landlord Considerations
Becoming a landlord is something you may have thought about to provide additional income, support life goals, diversify assets, provide inheritance to offspring or fund retirement. Most view their buy-to-let as a long-term investment to contribute to their pension.
It’s wise to do your research first on regulations and tax requirements before becoming a landlord. If you’re thinking about investing, consider all aspects. In this blog we look at ways buy-to-lets support you financially, how they work, mortgages, taxes and how to reduce liability. While this overview is useful, we recommend you also seek the advice of a qualified accountant or professional before any decisions are made.
Return on investment
If you’re purchasing a property, it can provide you with an income stream and act as a long-term investment.
When someone is living in your buy-to-let, you benefit from rental income or ‘rental yield’. How much you receive depends on a variety of things, from the property, to whether you use a letting agent. . You need to factor in periods when the property may be empty, mortgage repayments and maintenance costs. However, letting out a property can still boost your income.
Historically, property has risen in value. So, if you purchase a buy-to-let and sell it later, you could make a profit. The average property in the UK in January 2002 was worth £97,623. Two decades later in January 2022, the price increased to £275,743. Property can act as a long-term investment, but growth is not guaranteed, despite rental growth reaching a 13-year high at the end of 2021. In the final quarter of the year, average rent increased by 8.3% to £969.
Risks of a buy-to-let
While a property can add value, there are risks to consider. These could reduce the profitability of a buy-to-let property and can be time consuming to deal with. For example, void periods, where there is no tenant, could mean you won’t be receiving an income from the property. During void periods, you’d still need to meet your own financial commitments, like mortgage repayments. So, it’s important that you have a financial safety net to fall back on. In addition, tenant-related risks to consider. For example, what would happen if a tenant stopped paying rent or left the property in a state that wasn’t fit to rent to someone else? You can take out landlord insurance to provide some protection in these instances. It’s important to understand the effect these circumstances could have before you jump into buying a buy-to-let property.
How buy-to-let works
You can’t purchase a buy-to-let property with a normal residential mortgage. Even if you’ve taken out a mortgage to buy a home before, there are some important differences that you may not know about. If you’re purchasing a home, it’s common to put down a minimum of 5–10% of the property’s value as a deposit. However, for a buy-to-let mortgage, you’re likely to need a much larger deposit. Usually, you’ll need a minimum deposit of 20% and 40% if you want to access the best deals.
The amount you borrow on a buy-to-let mortgage will usually be determined by rental income the property generates. Lenders calculate interest cover ratio (ICR), profit against mortgage repayments. Lenders typically require rental income to be 125%+ of the mortgage payments. Buy-to-let mortgages are usually interest-only, you’ll just be paying off interest on the amount borrowed. However, end of the mortgage term, you still owe the full amount borrowed. You may decide to take out another mortgage, sell the property, or make provisions so that you can pay off the loan.
3 taxes to consider
If you’re letting out a property, you will need to consider tax from when you purchase the property right through to when you sell it. It’s important to understand what your tax liability will be and how it will affect your overall plans. Here are three key taxes you need to consider if you want to purchase a buy-to-let.
- Stamp Duty (England) / Land Transaction Tax (Wales)
Stamp Duty is a type of tax that you pay when you purchase residential property or land in England and Northern Ireland, while Land Transaction Tax applies in Wales. The rate depends on the value of the property. There is a 3% surcharge if you’re purchasing additional properties, including properties you’ll rent out. So, the rate you pay could be higher than you expect. The table below shows the Stamp Duty rates for the 2022/23 tax year while the Welsh equivalent Land Transaction Tax information can be found at Gov.Wales and the differences between LTT and SDLT rates is also at Gov Wales.
STAMP DUTY TAX RATES
| stamp duty | stamp duty rate for additional properties | |
|---|---|---|
| Up to £125,000 | 0% | 3% |
| The next £125,000 (the portion from £125,001 to £250,000) | 2% | 5% |
| The next £675,000 (the portion from £250,001 to £925,000) | 5% | 8% |
| The next £575,000 (the portion from £925,001 to £1.5m) | 10% | 13% |
| The remaining amount (the portion above £1.5m) | 12% | 15% |
If you’re buying a home in Wales, you will pay Land Transaction Tax (LTT) if the property costs more than £225,000 (from 10 October 2022) up from the threshold of £180,000 (before 10 October). If you’re buying an additional property, you will need to pay the higher residential rates for each band (6% on the next £175,000, 7.5% on the next £10,000).
LAND TRANSACTION TAX RATES
Changes from 10 October 2022 are in brackets
| Minimum property purchase price | Maximum property purchase price | Stamp Duty rate |
|---|---|---|
| £0 | £180,000 (£225,000) | 0% |
| £180,001 (£225,001) | £250,000 (£400,000) | 3.5% (6%) |
| £400,001 | £750,000 | 7.5% |
| £750,001 | £1,500,000 | 10% |
| Over £1,500,000 | 12% |
You’ll need to submit a Land Transaction Tax (LTT) return and pay what you owe to the Welsh Revenue Authority within 30 days of the day after completion (or other effective date of the transaction). If you don’t submit a return and pay the tax, Welsh Revenue Authority might charge you penalties and interest. You must pay Stamp Duty within 14 days from the completion date. As a result, it’s essential that you understand how much you will need to pay and include this in your budget when you’re purchasing a buy-to-let property.
2. Income Tax
As a landlord, you’ll normally need to pay Income Tax on the rent you receive from your property. In addition, you may need to pay Income Tax on other payments from tenants for services you may provide as a landlord, such as cleaning communal areas, utility bills, or arranging repairs to the property. Non-refundable deposits and any money that you keep from a refundable deposit at the end of a tenancy will also count as income.
The rate of Income Tax you pay will depend on your total income. So, you’ll need to consider things like your salary and pension when calculating how much tax you’ll be liable for. Keep in mind that rental income could push you into a higher tax bracket. The below table shows the Income Tax thresholds in England, Wales, and Northern Ireland for the 2022/23 tax year.
There are allowances and deductions that could reduce the amount of Income Tax you will be liable for, which are covered later in this guide.
| Income Tax Band | Taxable Income | Tax rate |
|---|---|---|
| Personal Allowance | up to £12,570 | 0% |
| Higher rate | £50,271 to £150,000 | 40% |
| Additional rate | Over £150,000 | 45% |
Income Tax bands are different in Scotland. If your total income from UK property is £10,000 or more for the tax year (before expenses are deducted), you must complete a tax return. You will also need to do this if your rental income is more than £2,500 after deducting rental expenses. If your income after deductions is under £2,500, HMRC may be able to collect the tax through the PAYE system if you’re paying tax this way, either through a salary or your pension.
3. Capital Gains Tax
Finally, you may be liable for Capital Gains Tax (CGT) if you sell the property in the future. CGT is a type of tax that you pay when you sell some assets, including property that isn’t your main home, and make a profit.
For the 2022/23 tax year, you have a CGT allowance of £12,300. So, if the profit you make when selling assets falls below this threshold, you won’t need to pay CGT. The rate of CGT you pay on profits above the allowance depends on your Income Tax band. However, for profit made on the sale of residential properties, it can be as high as 28%. Understanding what CGT will be payable is crucial for calculating how much you’ll make when selling a buy-to-let property. While CGT may not be something that will affect your plans now, it could affect your long term goals and whether purchasing property is the right option for you.
You must keep records for at least five years after the 31 January tax return deadline for each tax year. HMRC can charge you a penalty if your records are not accurate, complete, and readable, or if you do not keep them for the required time period.
How to reduce tax liability
Changes in recent years mean that allowances available to landlords aren’t as generous as they once were. For instance, landlords can no longer deduct mortgage interest from their income. However, there are still steps you can take to reduce your tax liability. As an individual, the first £1,000 of your income from property rental is tax-free. This is known as the “property allowance”. You can also deduct some expenses from your rental income if you pay for them yourself when calculating your tax liability. This may include things like:
- General maintenance and repairs to the property, but not improvements
- Water rates, Council Tax, gas, and electricity
- Insurance, such as landlords’ policies for buildings, contents, and public liability
- Cost of services, such as the wages for gardeners or cleaners
- Letting agent fees and management fees
- Legal fees for lets of a year or less, or for renewing a lease for less than 50 years
- Accountant’s fees
If you have more than one property, all rental receipts and expenses can be lumped together. So, expenses on one property can be deducted from receipts of another.
You can also deduct expenses that are “wholly and exclusively” for the purpose of renting out the property. For example, if you purchase cleaning products specifically for cleaning the rental property before a new tenant moves in, you can deduct these expenses. However, you cannot deduct the cost of a new vacuum cleaner for your home, which you use to clean the rental property. Depending on your circumstances there may be other things you can do to reduce your tax liability, such as setting up a limited company. If you’d like to discuss your options, please contact us.
Let’s Talk
Do you have questions about buy-to-let mortgages or taxes for landlords?
If you have questions about how a buy-to-let mortgage will work and what option is right for you, or you want support to reduce your tax liability, please contact us to ensure a view your own unique position. Let’s Talk.
