What is Buy-To-Let Tax?

As understood by the name itself, it is the tax you pay on the property which you have bought and rented it out for additional income. Investing in a buy-to-let property is very different than buying property for your own residential purpose and it is more like starting or rather getting ready for a small business. Buy to let is for sure a good way to have additional income however you need to have a good judgment and consider all the aspects like change in the tax law, possibility of rent not coming in, increase in the interest rate etc and not to mention, the added responsibility which comes as a new landlord.

What is Buy-To-Let Tax?

Your success with buying to let depends on choosing the right property and you, as a future landlord must consider three important points before buying the to-let property, such as:

  1. Location of the property: A good location is for sure most important factor to consider because if you are going to manage the buy-to-let property on your own, then you have to ensure that you don’t stay very far from it else it would become a logistic issue for you to do so. In addition to this, you need to consider a location which has high demand for rental property else whole idea of investing in a buy-to-let property will go down the drain. In case, you do not have much of an idea on these factors, you can consider taking help of agents and understand and have a rounded view of the local market.

  2. Possible tenants: You need to decide on your possible tenants as in whom you would prefer to rent out your property and who are your ideal tenants? Students? Families? Working and single professionals? Because depending on the section or type of tenants, you can determine and calculate the rental income from the buy-to-let property. Because each section of tenants have a very different requirement of the property and different considerations for its location. So, in case you target wrong section, you might end up struggling to rent out your property successfully and if your property stays empty for a longer duration, you will lose income.

  3. Rental Income: You need to decide a benchmark or a set rate of rent in order to cover for your costs, considering how much you going to spend on the buy-to-let mortgage payments and other costs such as insurance, repairs and agent’s fess if applicable. A better understanding of the market and how other landlords have priced their rental property will be of help in deciding on the rent of your rental property, since it is your rental income which will also determine how much you can borrow through a buy-to-let mortgage. So, it becomes even more important for you to have a rounded understanding of the market and the rent trend at a particular location depending on the tenant section you are planning to opt for.

Which All Costs Need to be Considered While Selecting a Buy-To-Let Property?

While a buy-to-let property can help in generating an additional income for you, you need to consider all costs, both upfront and ongoing to ensure that it is going to be a profitable project for you and best way to ensure the same is to get some financial and legal advice before purchasing a buy-to-let property. Costs which need to be considered are:

  1. Mortgage Costs: Apart from the mortgage fee, which is 25% of the total value of the property, you need to consider the monthly mortgage fees and additional arrangement fees, which is normally higher for the buy-to-let properties as compared to residential ones. Like in the case of residential mortgages, there are costs associated with the buy-to-let mortgages as well, such as legal fees, valuations, tax, surveys and stamp duty tax and these are higher in value for a buy-to-let property as compared to residential properties.

  2. Insurance Costs: For you to get a mortgage on your buy-to-let property, you need to have building insurance on your property and in case you plan to rent it furnished then you have to consider the insurance of the contents as well. And while you consider all these costs, it is highly advisable and wise move if you cover yourself against the additional risks associated with letting a property such as landlord’s liability, rental guarantee and emergency repair assistance.

  3. Agent Fees: In case you plan to manage your rental property all by yourself, you save yourself from the agent fees however, if you plan to rope in an agent for managing your property for you, you will need to factor in this cost as well and how much you pay to the agent will depend on the level of service you are planning to hire from him, which could range easily from 5% to 15% of your monthly rental income. Having an agent also helps you in deciding a prime location for your rental property with high demand for rental properties.

  4. Income Tax: So, as soon as you start generating income from your rental property, you have to inform Her Majesty’s Revenue & Customs (HMRC) about the same and report your rental income to them every year. Since tax laws can change, it is advisable to have a financial and tax advice from an expert on the same. Any income you receive from the rent is taxable and you have to declare the same in your Self-Assessment tax return and the tax on your income is then charged based on the income tax band i.e. 20% for basic taxpayers, 40% for higher rate and 45% for additional rate.

    However, you can reduce your tax by deducting certain allowable expenses from your taxable rental income, such as:

    • Interest on buy to let mortgages and other finance charges.
    • Council tax, insurance, ground rents etc
    • Property repairs and maintenance – however large improvements such as extensions etc will not be income tax deductible. They will be added to the cost of the property when it is sold and be deductible against any capital gain.
    • Legal, management and other professional fees such as letting agency fees.
    • Other property expenses including buildings insurance premiums.

  5. Ongoing Maintenance and Repair: Once you buy a property, maintenance and repair of it will become a routine affair, if not a daily affair and it for sure involves costs. So, you need to consider this cost along with other costs. Because as a legal owner and a landlord, you become legally responsible to keep your property in a good shape.

Taxes on Buy-To-Let Property:

Apart from Income tax, there are various taxes which may affect your rental property such as:

Taxes on Buy to Let Property

  1. Stamp Duty: Stamp Duty or Stamp Duty Land Tax (SDLT) is payable on a buy to let property and its price varies depending on the price of your rental property. The current rates of stamp duty is as below:

    • 3% tax on the first £125,000
    • 5% on the portion up to £250,000
    • 8% on the portion up to £925,000
    • 13% on the portion up to £1.5 million
    • 15% on everything over that

    Stamp duty has to be paid within 30 days from the date of purchase of your rental property, however, solicitor pays it only after the completion and its amount is deductible from any capital gains which you might make when the property is sold.

  2. Inheritance Tax: At times, you might need to pay inheritance tax on your buy-to-let property. In case your estate exceeds £325,000 or up to £650,000 for married couples or civil partners, inheritance tax is charged at 40% on everything above this threshold, except those estates which are passed to the spouse or to the civil partners, which are free from the inheritance tax.

  3. Capital Gains Tax: In case you sell the property for more than you have paid for it after deducting costs such as stamp duty and estate agent/solicitor fees, you need to pay the capital gains tax on it because you make a profit by selling it at a higher price. However, since you are an individual, you get an annual allowance to set against any gain and for the year 2016/17, this allowance is £11,000 and in case you gain more than the allowance, you need to pay the tax at a rate of either 18% or 28% on the profit depending on the amount of income and capital gains you might make.

    You can reduce your capital gain tax liability by:

    • A loss made on the sale of a buy to let property in previous years.
    • Solicitor fees.
    • Estate agent fees.
    • Cost of advertising the property for sale.
    • Stamp duty.
    • Any expenditure on “capital” items.
  4. -

Changes to Buy-to-Let Tax Relief:

2017 witnessed a major change in the buy-to-let taxation policies which were originally announced in the year 2016; however, they got implemented in the year 2017 and it mainly affected mortgage interest payments. Before 2017, it was possible for the higher rate taxpayers to offset these payments against their rental income however, from 2017, it became difficult and thus resulted in higher tax bills.

Changes to Buy-to-Let Tax Relief

In simpler words, earlier people buying to let have been able to claim tax relief on their mortgage interest payments at their marginal rate of tax i.e. the basic rate tax payer would get 20% tax relief whereas the higher rate tax payer would get 40% tax relief and top-rate taxpayers could claim 45% tax relief. However, post the changes to buy-to let tax relief, a flat 20% tax relief will be available to all, irrespective of whether you are a basic or a higher or a top-rate taxpayer. So, those who were at basic rate tax would see no change but those who were at higher or at a top-rate tax band will find losing more money.

This change in buy-to-let tax relief will be phased out gradually from April 2107 to April 2020 to ensure that there is no sudden increase in the income tax for the landlords. However, even with this approach, the impact on the landlords is going to be quite severe. For example:

Someone with a £150,000 buy-to-let mortgage on a property worth £200,000, with a monthly rent of £800, would currently have a net profit of around £2,160 a year. Under the new system, the net profit would plunge to £960.

However, there are ways in which landlords may be able to at least minimize the impact of the changes, such as by increasing the rent of their buy-to-let property or by converting mortgages into a repayment plan.

Buy-to-Let Mortgage and Buy-to-Let Tax Calculator:

When you are planning to buy an additional property apart from your residential property, in order to let it out for an additional income, you need to understand how much potential rental income you can generate on it because based on this calculation, mortgage lenders will decide whether to lend to you or not.

There are various calculators online to calculate the same for you based on certain factors such as expected rental income from the buy-to-let property, tax deductible costs, mortgage interests, earnings and other non-savings income, savings income and net dividend income.

You can consult our experts to help you in calculating your buy-to-let mortgage for a better understanding.

Similarly, you need to calculate how much tax you are going to pay on your rental property to ensure that you are having a sizeable or at least expected profit from it. While calculating the same, you need to consider factors, such as:

  1. Rental income
  2. Tax deductible costs
  3. Mortgage interest
  4. Pre-tax profit
  5. Tax relief %
  6. Taxable mortgage interest
  7. Tax credit rate
  8. Tax credit amount
  9. Taxable profit

For queries related to buy-to-let tax changes, you can get in touch with our experts at info@dnsaccountants.co.uk

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