Tax

Tax is an aspect of Residential Property Investment which is often overlooked. There are many twists and turns to consider at all levels, whether it be for Income Tax, Capital Gains Tax or Inheritance Tax, and it is important to get the structure of ownership right and to make sure that all tax relief, allowances and claims are made.

This section summarises some of the main aspects of the principal areas of Property tax. There are many detailed aspects to consider at each stage, and it is very important to obtain good professional advice if you have any doubts as to the applicability of any rule.

The tax implications for commercial property are, in many instances, very different and have not been addressed here.

All areas of tax require you to practice good record keeping (this is equally applicable when you sell a property). It is essential that you keep full and accurate records of all income and expenditure, perhaps maintaining a separate bank account for these, so that you can be sure that you have all of the ammunition to allow you to claim the maximum deductions and thereby pay the minimum amount of tax.

>> Income tax

If you are a new property investor you should promptly notify HM Revenue & Customs (HMRC) of the new source of income which you are now receiving. The tax is computed through the annual Tax Return sent to HMRC.

Income Tax is payable on profits made from the property renting business by computing the total of rents receivable less expenses. Tenants’ deposits do not count as income.

Typical expenses which can be deducted include: repairs and maintenance (though not initial expenditure needed to bring the property up to a letting standard, or improvements); gardening; cleaning; ground rents; service charges; contents and building Insurance; managing agent’s fees; legal fees for tenancy agreements; advertising; HMO licence costs; interest (not the capital repayments) on loans used to buy or improve the property; water rates and council tax; heating and lighting; security, accountancy fees; motor and travelling expenses for visiting the property and for attending to matters relating to let properties. Further a special wear and tear allowance of approximately 10 per cent of the rents received can be claimed if the property is let furnished. This list is not exhaustive and can vary in individual circumstances.

On the question of repairs and maintenance, it is important to distinguish between items of repair, and items of improvement. Redecorating rooms, changing windows from single to double-glazing, or replacing a defective roof, are examples of repairs which will be allowable. The addition of another floor to the building, or a new conservatory, would not qualify, and tax relief would only be received on the eventual sale of the property, being set against the eventual Capital Gain. There may however, be special cases where property improvements can be tax deductible.

>> Structure

Where properties are owned in joint names, then the profits can be shared between the joint owners or, in certain circumstances, can be wholly attributable to one or other of the joint owners. Where a husband and wife own a property jointly, the income is automatically assessed equally, even if the actual ownership proportion is not equal, unless they elect otherwise.

For Capital Gains Tax purposes, the proportionate ownership is important, and any Capital Gain would be shared between the joint owners in their respective proportions thus giving rise to multiple tax-free allowances.

In certain circumstances, it may be worthwhile for a Limited Company to be brought into the structure. It is normally sensible for the properties themselves to be held in individual or joint names, but these can be sub-let to a company who then let out the properties to the ultimate tenants. In this way, the let income from the property is taxed at the lower rate of Corporation Tax, thus leaving more for the ultimate owners.

>> Capital gains tax

Capital gains tax is a tax landlord’s only pay on disposal of their buy-to-let investment property. It is treated as a top slice of taxable income and therefore the rate that a landlord will pay will depend on what income they have earned in the year of disposal. In calculating a landlord’s potential Capital Gains Tax (CGT) tax liability a landlord will have to apply the following concepts to their Capital Gains Tax (CGT) calculation:

Establish the base cost of their buy-to-let investment (effectively cost of acquisition)
Establish the size of the gain by taking base cost from disposal value
Establish if buy-to-let investment held as a non-business or as a business asset (most will be non-business, whilst holiday rentals are classed as a business asset)
If the buy-to-let investment property is held as an individual not by a company the landlord can use their annual exemption 2006/2007 £8800 to reduce the amount of the chargeable gain
For properties bought before April 6 1998 the gain is subject to indexation
Properties bought on or after April 6 1998 the gain is subject to taper relief

Effective rate of Capital Gains Tax (CGT): For most landlords the effective rate of Capital Gains Tax (CGT) that a landlord will pay depends on their rate of income tax. For a landlord who is a basic rate tax payer the effective Capital Gains Tax (CGT) rate could reduce to 12% as the percentage of the gain chargeable reduces to 60% after 10 years and this is then charged at 20%. For landlords who are top rate tax payers the effective rate is double as they pay 40% tax.

>> The new regime

The new Chancellor Alistair Darling is planning to sweep away the old systems of indexation and taper relief carefully put in place by the previous Chancellor and replace the systems of indexation and taper relief with a single flat rate of 18%.

The new flat rate Capital Gains Tax (CGT) will apply to a landlord immediately and means that for a high rate tax payer they will be paying 6% less than they would have done after 10 years under the previous system of taper relief. For basic rate tax payers things are less clear cut. Under the previous system a basic rate tax payer would have had to have held their buy-to-let investment property for 4 years before benefiting from a rate as low as 18%. However, this would have eventually reduced to 12% after 10 years or 6% below the rate that will come in on 6th April 2008.

A couple of beneficial points for landlords are that the new system is much simpler to understand and should make disposal decisions and calculations much easier for landlords.

It also makes it far more attractive for landlords to trade their buy-to-let investments buying and potentially renovating a property, holding for a couple of years before then selling their buy-to-let investments on.

>> Inheritance tax

Where a property is owned at date of death, the value of that property forms part of your Estate and is potentially liable to Inheritance Tax (IHT). If the property is left to your spouse in your Will, then no IHT would be payable until the death of your spouse, but IHT is inevitably payable.

Recent changes mean that the threshold at which IHT becomes payable has been raised for married couples to £600,000 (this figure was correct in January 2008, for up-to-date figures please see the HM Treasury website. This increase has come about because spouses can now transfer their individual allowance, essentially giving a doubling of the threshold.

There are ways of reducing the IHT liability. If properties are held in joint names (as tenants-in-common rather than joint tenants) from the outset, then only a proportion of the value of the property will fall into your Estate. And because you do not own all of the property, a discount can be applied to the proportionate value, thus reducing the IHT even further. A tax efficient should be drawn up to ensure maximum use of IHT allowances.

A typical arrangement would be to include a Mini-Discretionary Trust within the Will. However, it is always best to consult a financial advisor, as they will be able to advise you of any recent changes.

>> Furnished holiday lettings

There are special rules for such properties, which benefit from additional Income Tax, Capital Gains and Inheritance Tax reliefs. The rules are complex and proper professional advice is essential.

>> Stamp duties

Stamp Duty Land Tax (SDLT) is payable by the purchaser on the cost of the property. The rates depend upon whether the property is in normal areas in the UK or in ‘disadvantaged areas’. The list of areas which are included as disadvantaged is much wider than one would imagine, although this only applies to lower valued properties. A postcode search can be found by clicking here, this will enable you to see if your property could qualify.

The rates of SDLT for residential property as of November 2007 are as follows: (the latest rates can be seen on the HMRC website here)

Rate	Disadvantaged areas	All other areas
0%	£0 - £150,000	£0 - £125,000
1%	£150,001 - £250,000	£125,001 - £250,000
3%	£250,001 - £500,000	£250,001 - £500,000
4%	£500,001 and over	£500,001 and over

The value of any fixtures, fittings or furniture included in the purchase can be excluded from the purchase price in calculating the SDLT payable, though the Stamp Duty office will look at any obvious overloading in this regard.

>> Value added tax (VAT)

Under normal circumstances, Landlords cannot register for Value Added Tax (VAT) in relation to their residential properties; as such rental income is exempt from VAT. This means that any VAT incurred cannot be reclaimed. However, Landlords who are VAT registered in their own self employed businesses may be able to claim some VAT incurred.

A special VAT rate of 5 per cent is available on the renovation or alteration of a single household dwelling that has not been lived in for three years or more, so that this is a useful saving over the normal 17.5 per cent rate.

More information on tax can be obtained from your tax office or visit the Inland Revenue website

You can also get copies of leaflets on taxation of rents and other tax matters from the website, or by phoning the Order Line on:

08459 000 404

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