Buy to Let Investment Follow-up Facts

On the basis that investment in property appears to make commercial sense what tax factors should you take into account? If you are considering property investment we, at Levicks, can help you to make property investments in a tax efficient manner.

Investment in property has been and continues to be a popular form of investment by many people. It is seen as a route by which:

• relatively secure capital gains can be made on eventual sale
• income returns can be generated throughout the period of ownership
• mortgage finance is covered in repayment terms by the security of the eventual sale of the property and in interest terms by the rental income.

Of course, the net returns in capital and income will depend on a host of factors. But on the basis that the investment appears to make commercial sense what tax factors should you take into account?

Who or what should purchase the property?

An initial decision needs to be made whether to purchase the property:

• as an individual
• as joint owner or via a partnership (often with a spouse)
• via a company.

There are significant differences in the tax effects of ownership by individuals or a company.
Deciding the best medium will depend on a number of factors.

Commercial property

You are currently trading as a limited company

The personal purchase of new offices or other buildings and the charging of rent for the use of the buildings to your company is very tax efficient from an income tax position as:

• the rental you receive from the company allows sums to be extracted without national insurance
• the company will claim a corporate tax deduction for the rent
• finance costs will be deductible from the rents.

Capital gains

Capital gains on the disposal of an asset are generally calculated by deducting the cost of the asset from the proceeds on disposal and reducing this by the annual exemption. Gains are treated as an individual’s top slice of income and taxed at 18% or 28% or a combination of the two.

Capital gains tax and Entrepreneurs’ Relief (ER)

Unfortunately ER is unlikely to be available on the disposal of business premises used by your company where rent is paid. This is due to the restrictions on obtaining the relief on what is known as an “associated disposal”. These restrictions include the common situation where a property is currently in personal ownership, but is used in an unquoted company or partnership trade in return for a rent. Under the ER provisions such relief is restricted where rent is paid from 6 April 2008 onwards.

Residential property

The decision as to who should own a residential property to let is a balancing act depending on overall financial objectives.
The answer will be dependent on the following factors:

• do you already run your business through your own company?
• how many similar properties do you want to purchase in the future?
• do you intend to sell the property and when?

Do you already have a company?

If you already run your business through a company it may be more tax efficient to own the property personally as you will be able to make use of your CGT annual exemption (and spouse’s annual exemption if jointly owned) on eventual disposal to reduce the gain.
The net rental income will be taxed at your marginal rate of tax, but if you are financing the purchase with a high percentage of bank finance, the income tax bill will be relatively small.
In contrast, a company can still currently use indexation allowance to reduce a capital gain. This effectively uplifts the cost of the property by the increase in the Retail Price Index over the period of ownership. Indexation is not available to reduce the gain on the disposal by an individual so in situations where indexation allowance is substantial, this could result in lower gains.
The net rental income will be taxed at the company’s marginal rate of tax, which is generally lower than for an individual but again if the purchase is being financed with a high percentage of loan/bank finance, the corporation tax bill will be relatively small.
But there are other factors to consider:

• there is frequently a further tax charge should you wish to extract any of the proceeds from the company
• inserting the property into an existing company may result in your shareholding in that company not qualifying for ER
• if you form another company to protect the trading status of the existing company, that may increase the corporation tax bill on your trading company (because of ‘associated company’ rules).

If you do not have a company at present

Personal or joint ownership may be the more appropriate route but there are currently significant other advantages of corporate status particularly if you expect that:

• you will be increasing your investment in residential property and
• you are unlikely to be selling the properties on a piecemeal basis or
• you are mainly financing the initial purchases of the property from your own capital.

If so, the use of a company as a tax shelter for the net rental income can be attractive.

Use of company as a tax shelter

Profits up to £300,000 are currently taxed at 20%. This rate applies for trading companies or property investment companies.
Where profits are retained the income may be suffering around half of the equivalent income tax bills. That means there are more funds available to buy more properties in the future.

Tax efficient long-term plans

There are two potential long-term advantages of the corporate route for residential property:

• is there an intention to sell the properties at all? May be the intention is to retain them into retirement (see below Using the company as a retirement fund)
• can the shares be sold rather than the property?(see below for issues regarding Selling the shares)

Using the company as a retirement fund

A potentially attractive route is to consider the property investment company as a ‘retirement fund’. If the properties are retained into retirement, it is likely that any initial financing of the purchases of the property has been paid off and there will be a strong income stream. The profits of the company (after paying corporation tax) can be paid out to you and/or your spouse as shareholders.
To the extent that the dividends when added to your other income do not exceed your personal allowances and the basic rate band, there will be no income tax to be paid.

Selling the shares

CGT will be due on the gain on the eventual sale of the shares.
The share route may also be more attractive to the purchaser of the properties rather than buying the properties directly, as they will only have 0.5% stamp duty to pay rather than the potentially higher sums of stamp duty land tax on the property purchases.

Stamp duty land tax (SDLT)

SDLT is payable by the purchaser and is a flat percentage of the consideration paid (up to 7%).
Where the consideration on residential property is £125,000 or less no SDLT is payable.

Corporate investment in expensive residential property

In 2012 a new top rate of SDLT was introduced where expensive residential property, valued at more than £2 million, is purchased by a ‘non natural person’ broadly a company. With effect from 20 March 2014 the value limit was reduced to £500,000 for acquisitions on or after this day.
From 1 April 2013 a further annual charge, the Annual Tax on Enveloped Dwellings (ATED) has been introduced. The ATED is between £15,000 and £140,000 depending on the value of the residential property.
It is proposed that there will be two new bands for ATED. Residential properties worth over £1 million and up to £2 million will be brought into charge with effect from 1 April 2015.  Properties worth over £500,000 and up to £1 million will be brought into charge with effect from 1 April 2016.
At present CGT is charged at 28% on disposals of properties liable to ATED. This will be extended to residential properties worth over £1 million with effect from 6 April 2015 and for residential properties worth over £500,000 from 6 April 2016.

How we can help

This factsheet has concentrated on potentially long-term tax factors to bear in mind with property investment.
You need to decide which is the best route to fit in with your objectives. At Levicks, we can help you to plan an appropriate course of action for your property investment.

Buy to Let Property Investment Facts

Buy to let traditionally involves investing in property with the expectation of capital growth with the rental income from tenants covering the mortgage costs and any outgoings. At Levicks, we can help you sort out some of the potential problems that may arise and structure the investment appropriately.

In recent years, the stock market has had its ups and downs. Add to this the serious loss of public confidence in pension funds as a means of saving for the future and it is not surprising that investors have looked elsewhere.
The UK property market, whilst cyclical, has proved over the long-term to be a very successful investment. This has resulted in a massive expansion in the buy to let sector.
Buy to let involves investing in property with the expectation of capital growth with the rental income from tenants covering the mortgage costs and any outgoings.
However, the gross return from buy to let properties - ie the rent received less costs such as letting fees, maintenance, service charges and insurance - is no longer as attractive as it once was. Investors need to take a view on the likelihood of capital appreciation exceeding inflation.

Factors to consider

Do

• think of your investment as medium to long-term
• research the local market
• do your sums carefully
• consider decorating to a high standard to attract tenants quickly.

Don‘t

• purchase anything with serious maintenance problems
• think that friends and relatives can look after the letting for you - you‘re probably better off with a full management service
• cut corners with tenancy agreements and other legal documentation. 

 Which property?

Investing in a buy to let property is not the same as buying your own home. You may wish to get an agent to advise you of the local market for rented property. Is there a demand for say, two bedroom flats or four bedroom houses or properties close to schools or transport links? An agent will also be able to advise you of the standard of decoration and furnishings which are expected to get a quick let.

Agents

Letting property can be very time consuming and inconvenient. Tenants will expect a quick solution if the central heating breaks down over the bank holiday weekend! Also do you want to advertise the property yourself and show around prospective tenants? An agent will be able to deal with all of this for you.

Tenancy agreements

This important document will ensure that the legal position is clear.

Taxation

When buying to let, taxation aspects must be considered.

Tax on rental income

Income tax will be payable on the rents received after deducting allowable expenses. Allowable expenses include mortgage interest, repairs, agent‘s letting fees and an allowance for furnishings.

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 and is then taxed at either 18% or 28% or a combination of the two rates. CGT is payable on 31 January after the end of the tax year in which the gain is made.

Student lettings

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.

Advantages

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’. This is £4,250 each year. 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 that could be considered. This form of letting is short holiday lets as opposed to letting for the residential market.
The favourable tax regime for furnished holiday letting accommodation has been significantly amended. Most importantly the regime has been extended to cover qualifying property located anywhere in the European Economic Area (EEA). This extension is effectively backdated and means that it may be possible to claim the benefits of FHL treatment of losses and capital gains in UK tax years within the normal four year time limit.
The conditions necessary to qualify for FHL treatment have been amended from 6 April 2012. From that date the property will have to be available for letting for at least 210 days in each tax year and must actually be let for 105 days. Provided that there is a genuine intention to meet the actual letting requirement it will be possible to make an election to keep the property as qualifying for up to two years even though the condition may not be satisfied in those years. This will be particularly important to preserve the special CGT treatment of any gain as qualifying for the lower CGT rate of 10% where the conditions for Entrepreneurs’ Relief are satisfied.
One area of previous benefit which has now gone is that losses arising in an FHL business can no longer be set against other income of the taxpayer. This change applies for the 2011/12 tax year onwards. It also becomes necessary to segregate losses into UK losses and EEA losses. Each can only be offset against profits of the same or future years in each relevant sector.
FHL property has some advantages but it has other disadvantages which should also be considered.

Advantages

You will be able to take a holiday in your own property, or make it available some of the time to your family or friends. However, care would need to be taken to adjust the level of expenses claimed to reflect this private use.
Generally however the rules for allowable expenditure are more generous.

Disadvantages

Holiday letting will have higher agent’s fees, advertising costs, and maintenance fees (for example more regular cleaning).
Owning a holiday property may be more time consuming than you think and you may find yourself spending your precious holiday sorting out problems.
If you would like any further advice in this area please get in touch.

How we can help

Whilst some generalisations can be made about buy to let properties it is always necessary to tailor any advice to your personal situation. Any plan must take into account your circumstances and aspirations.
Whilst a successful buy to let cannot be guaranteed, professional advice can help to sort out some of the potential problems and structure the investment correctly.
We would be happy to discuss buy to let further with you. Please contact us at Levicks for more detailed advice.