Buy to let tax guide
Landlord guide on capital gains tax and income on buy to let property
Buy to let property can be profitable, but you have to be mindful of the taxes that you will have to pay, which will impact your revenue. Here is your definitive guide to tax on buy-to-let property, which details what taxes may be levied on your property, both when you buy it and also on the income you make from it.
- How to work out a rental yield
- What are the cost of buying a buy-to-let property
- How to avoid investor stamp duty on a second home?
- Calculate income tax on buy-to-let
- Capital Gains Tax on buy to let
- Frequently asked questions about buy to let property tax
We are often asked how to calculate rental yield on investment property. The net yield on property is the gross annual income minus the annual expenses. The answer is then divided by the purchase price of the buy to let property. The answer is easily found with this equation:
The total income you received on your investment property from the rental income from your tenant is known as the gross annual income.
Annual expenses on a buy-to-let property can include lettings management fees, service charge, ground rent, licensing fees, credit checks fees and advertising costs for finding a tenant.
Sometimes people ask if your return on property investment is the same as the net yield?
Your property investment returns is calculated over the holding period and can include the profit that is realised from the sale of the property otherwise - known as the capital gain - as well as all the total net income obtained during the holding period. Whereas net yield is simply the net income per annum.
Buy to let property purchase costs are calculated by adding the property purchase costs such as solicitors fees, stamp duty, mortgage brokers fees and the bank’s mortgage application fee.
Stamp duty is applicable to anyone buying property over a certain price in England and Northern Ireland.
The current threshold is £125,000 for residential properties and £150,000 for non-residential land and properties. Any property bought below this value is not subject to stamp duty charges.
The tax is tiered depending on the value of the property. Below are the bands. It is worth noting if your property is £400,000, the entire sum is not subject to 5% stamp duty. 0% will apply to the first £125,000, 2% will apply to the portion between £125,001 - £250,000 and stamp duty will be applied at 5% to the portion between £250,001 - £400,000.
Stamp duty is applied differently to first time buyers and those buying a second property.
One can reduce buy to let stamp duty by purchasing student property or care homes rooms because it is commercial property and the stamp duty exempt under £150,000 purchase price.
It is worth noting that until March 2021 there is a stamp duty holiday. This means that only investors stamp duty is applied, and regular stamp duty rates are not applied.
From April 2021, those investing in UK property from overseas will be subject to an additional 2% stamp duty.
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Those looking to buy an additional property, either as a second home or as a buy to let, must pay an additional 3% stamp duty for each band as well as current rates.
Do foreign investors pay UK stamp duty? Yes, just like any investor, stamp duty is applicable on property purchases. Most investors will have purchased their own home, so an addition 3% of the total purchase price is to the usual stamp duty. It is otherwise known as second home stamp duty.
Married couples are considered one entity, so stamp duty would be applicable if either party purchased residential property. One could not avoid investor second home stamp duty if your partner purchases the property in their name.
Up until March 2021, the government has introduced a stamp duty holiday, which means that only the additional 3% stamp duty is levied on property under £500,000. Other stamp duty rates are suspended.
There are a few changes to buy to let regulations and tax rules that you should be aware of before deciding to invest in the industry. The most notable being that landlords will no longer qualify for mortgage interest tax relief. Instead, landlords will receive a 20% tax credit for mortgage interest payments.
Capital Gains Tax is a tax applied to property owners who see their houses increase in value from the time they bought it to the time they sell it on. They are taxed on the increase with basic rate taxpayers taxed at 18% on the difference, and higher rate taxpayers taxed at 28% on the difference.
Before April 2020, if a landlord rents out a home that was once their main residence, Capital Gains Tax only applied to the amount the house went up in value when they weren’t living there. Before 2020, landlords could also add on an extra 18 months of time spent at the property, and this would also be exempt from Capital Gains Tax. From April 2020 this reduced to 9 months.
If you are wondering what mortgage interest tax relief is, you are not the only one. Prior to 2017, landlords could deduct mortgage interest payments from their profits before calculating tax. Since 2017 this has been gradually phased out and from the start of the 2020 tax year, landlords were no longer able to deduct mortgage interest payments from their rental income. Instead, you will only be allowed to subtract a flat rate of 20% of your mortgage expenses from your rental income.
Some investors choose to buy in a company name. They mainly choose to do this for tax purposes.
For example, if you were to buy in a company name, income generated through property would be subject to corporation tax. Corporation Tax stands at 20%, which is lower than the higher rate of Income Tax which is 40%.
If you bought as an individual, income generated through property would be added on to your other earnings. This may push you up to the higher tax bracket, and you may find yourself paying 40% on your earnings generated through property, rather than 20%.
If you bought property through a company, you may also be able to claim mortgage interest tax relief, which allows you to deduct mortgage interest payments from your income when submitting a tax return form.
Of course, there are some cons associated with investing as a company. There is limited mortgage availability and if you take money out, it will be subject to dividend taxation. This means that not only will income be subject to corporation tax, but it will also then be subject to dividend taxation. This may not be a problem for those who are leaving earnings alone to accumulate, but if you want to use the money to fund your lifestyle, it will likely work out more expensive.
Capital gains tax on property can be avoided by purchasing commercial property under £150,000. Purchasing commercial property such as care home rooms and hotel room investments which provide a high yield is one way of reducing your capital gains tax obligation. Where properties are purchased on a long-term lease with contracted rate of return which is fixed, when it comes to selling the property the potential buyers would also want the same yield. So, where the yield stays the same, there is little chance of selling the property for a capital gain. That way capital gains tax is mitigated.
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Frequently asked questions about buy to let tax
- What is the income tax paid for overseas investors?
- Does a non-resident still have to submits a tax return?
- Do foreign investors pay inheritance tax?
- What is selective licensing?
- What is an HMO licence and when do I need it?
What is the income tax paid for overseas investors?
An individual has a personal tax allowance of £12,500. Every individual is entitled to a personal allowance. Earnings over this amount will be subject to tax.
If you live overseas and earn income in the UK, you may not have to pay tax twice if your country has a “double-taxation agreement” with the UK. Depending on the agreement, you may either receive full or partial relief before being taxed or receive a refund after you have been taxed. You can visit the U.K Government website to find out if your country has a double taxation treaty with the U.K.
Does a non-resident still have to submits a tax return?
A UK non-resident purchasing UK property should complete their NRL1 form. The non-resident will be issued with an NRL1 number which they present to the lettings management company. Tax will not be deducted at source by the letting agent. However, non-resident landlords often think they do not have to submit a tax return. This is not true, an annual tax return still needs to be completed even if tax is not due.
Do foreign investors pay inheritance tax?
Inheritance Tax is the tax on the deceased’s estate (including property, money, and possessions). It is not applicable if the value of one’s estate is less than £325,000, or they leave it to their spouse, civil partner, charity, or community amateur sports club. The standard Inheritance Tax rate is 40%. So, if your estate is worth £500,000, £175,000 will be subject to 40% Inheritance Tax. The threshold increases to £500,000 if you give your home away to your children or grandchildren.
If you purchase property in the United Kingdom but you are domiciled overseas, Inheritance Tax will be applicable to any UK-based assets. This could be on a UK property or money in a UK-based bank account.
What is selective licensing?
Selective licensing is a scheme that aims to raise standards in rental properties, it can be applied to areas where there is low housing demand or problems with antisocial behaviour.
Selective licensing hasn’t been implemented countrywide. It is up to individual councils to implement the scheme as they see fit. Similarly, the scheme might not apply to an entire council-controlled area. If your property has been licensed under the HMO licensing scheme, then you will not need a selective licence.
The cost of a licence varies from council to council, ranging from £55 to £1,150. To be licensed, the council must be satisfied that you are a “fit and proper” landlord and that your property is up to standard to be rented out.
The failure to obtain a selective licence is a criminal offence can result in a fine and prosecution, or a penalty of up to £30,000.
What is an HMO licence and when do I need it?
An HMO is classified as a property that is rented out to at least three people who are not from the same household. They share facilities like a bathroom or kitchen but would have their own room. In England and Wales, it is sometimes necessary for landlords to have a licence to rent out a property on an HMO basis. It is decided by individual councils, so landlords would need to check with them to ascertain what is required.
If the house is rented to five or more people who form more than one household, it is classified as a large HMO. All large HMOs need to be licensed.
An HMO licence costs £1,100 and is valid for five years. It is issued on the basis that the house is fit for occupation. Landlords will need to provide updated gas safety certificates, install smoke alarms, and provide electrical safety certificates when required.
Having to obtain a licence is an extra expense for landlords, especially now when profits are already squeezed. If you are thinking about purchasing a buy to let property to rent out on an HMO basis, this expense is something to consider.
If you are at the beginning of your property search, you may want to devise a buy to let strategy, and one starting place for that will be to research the best places to invest in UK property. If you are further on in your investment journey, you may want to begin your property search. We have a wide range of investments to cater for most individual requirements and tax situation.
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