Buy to Let
Buy to let involves investing in property with the hope and expectation of capital growth and at the same time receiving rental income from tenants to cover mortgage costs and any other outgoings.
However, in recent years the overall return from buy to let properties - i.e. the rent received less costs such as letting fees, maintenance, service charges and insurance - has not been as attractive as it once was.
Potential investors will now need to take a view on the likelihood of capital appreciation exceeding inflation.
Letting property can also be time consuming and sometimes outright inconvenient. Tenants expect you to provide a quick solution, for example, if their central heating breaks down over a bank holiday weekend.
You should consider using a letting agent, and pass on the job of solving these types of problems to them. A letting agent will also show prospective tenants around, saving you the time and hassle.
Tax on rental income
Income tax is payable on the rents received after deducting allowable expenses.
Currently allowable expenses include mortgage interest (but see below), repairs, agent’s letting fees and an allowance for furnishings.
Restriction of loan interest relief for ‘buy to let’ landlords
Rules have been introduced to restrict the amount of income tax relief landlords can get on residential property finance costs to the basic rate of income tax.
Finance costs include mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans.
No relief is available for capital repayments of a mortgage or loan.
Landlords are no longer able to deduct all of their finance costs from their property income.
They will instead receive a basic rate reduction from their income tax liability for their finance costs.
These rules are being introduced gradually from April 2017, over four years.
The restriction in the relief is being phased in as follows:
- in 2017/18, the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
- in 2018/19, 50% finance costs deduction and 50% given as a basic rate tax reduction
- in 2019/20, 25% finance costs deduction and 75% given as a basic rate tax reduction
- from 2020/21, all financing costs incurred by a landlord will be given as a basic rate tax reduction
This restriction does not apply to landlords of furnished holiday lettings.
Replacement of furnishings
A relief enables landlords of residential houses to deduct the costs they actually incur on replacing furnishings, appliances and kitchenware in the property.
Tax on sale
Capital gains tax (CGT) will be payable on the eventual sale of the property.
The tax will be charged on the disposal proceeds less the original cost of the property, certain legal costs and any capital improvements made to the property.
This gain may be further reduced by any annual exemption available.
CGT is generally charged at 10%, within the basic rate and 20% for higher rates.
However 18% and 28% rates apply to chargeable gains arising on the disposal of residential property that does not qualify for private residence relief.
CGT is payable on 31 January after the end of the tax year in which the gain is made.
From April 2019, a payment on account of any CGT due on the disposal of residential property will be required to be made within 30 days of the completion of the disposal. This will not affect gains on properties which are not liable for CGT due to Private Residence Relief.
Buy to let may make sense if you have children at college or university.
It is important that the arrangement is structured correctly. The student should purchase the property (with the parent acting as guarantor on the mortgage). There are several advantages to this arrangement.
This is a cost effective way of providing your child with somewhere decent to live.
Rental income on letting spare rooms to other students should be sufficient to cover the mortgage repayments from a cash flow perspective.
As long as the property is the child’s only property it should be exempt from CGT on its eventual sale as it will be regarded as their main residence.
The amount of rental income chargeable to income tax is reduced by a deduction known as ‘rent a room relief’ (£7,500). In this situation no expenses are tax deductible. Alternatively expenses can be deducted from income under normal letting rules where this is more beneficial.
Furnished holiday lettings
Furnished holiday letting (FHL) is another type of investment to consider.
This form of letting is short holiday lets as opposed to letting for the residential market.
In order to qualify for FHL treatment certain conditions have to be met. More details can be found here.
Generally the rules for allowable expenditure are more generous but there are also disadvantages because holiday letting will have higher agent’s fees, advertising costs, and maintenance fees (for example more regular cleaning).
Tax allowance for property income
There is a £1,000 allowances for property income are available for income arising from 6 April 2017.
Where the allowance covers all of an individual’s relevant income (before expenses) then they will no longer have to declare or pay tax on this income.
Those with higher amounts of income have the choice of either calculating their taxable profits by deducting the allowance from their receipts or deducting the actual allowable expenses.
The allowances do not apply to income on which rent a room relief is given.