Buy-to-let: Top FAQs answered

In this article our Tax Partner, Oscar Wingham tackles some of the most frequently asked questions and explores ways to potentially mitigate the impact of these changes.

Last year the government made several alterations to the rules and reliefs available to buy-to-let investors. The two changes which I believe will have the most far reaching consequences on buy-to-let investors were:

• A restriction of higher rate tax relief on mortgage interest payments on residential property. This change means that tax relief on ‘finance costs’ such as interest on loans to buy furnishings and mortgage interest will be restricted to the basic rate of tax. Although the phased introduction over four years will mean that its full impact will be delayed, this will eventually (and significantly) change the profitability of mortgage/debt funded buy-to-let portfolios.
• A sharp 3% increase in Stamp Duty Land Tax rates for those investing in buy-to-let. This will apply on the purchase of ‘additional residential properties’, including buy-to-let and second homes after April 2016. There will also be a new starting threshold of £40,000 which will capture nearly all buy-to-let transactions.

With the increased Stamp Duty costs you will now have to pay more at the front end, but if you intend on holding the property for a long period this might not be such an issue to you.

The bigger challenge for those in buy-to-let is going to be the loss of higher rate mortgage tax relief, which could cause many buy-to-let investors to become cash flow negative and will certainly make investing in buy-to-let less attractive to those without sufficient funding in place. This could be further compounded by any potential interest rate rise the government announces in the coming years.

Over the longer term, I do not believe that buy-to-let will be wiped out, but we may see investors become smarter with how they structure and operate their property investments. It is perhaps now even more important to seek professional advice as to the structure and reliefs that will affect the profitability of your investment.

It is now essential for buy-to-let investors to plan ahead and keep a closer track of the costs associated with their property, including the likely tax costs. Using this information they can assess whether their rental income is sufficient to provide the returns that they need to make their investment worthwhile.

Also, since buy-to-let property held in companies are not affected, a possible solution may be to consider adopting a limited company structure. However, there are pro’s and con’s to consider and we would always advise that they seek professional advice before making a decision.

There are several benefits to holding your property in a private limited company, but the most notable are lower rates of taxation, and that the increased Stamp Duty rates and the restrictions to tax relief on mortgage interest payments do not currently apply to companies.

Corporation Tax rates are currently 20% but reducing to 19% from 1 April 2017 and to 18% from 1 April 2020, in contrast to Income Tax rates (which can be up to 45%). However, there will be further tax to pay when you extract it from the company, whether via salary or dividend.

You should also note that dividends (traditionally the most tax-efficient way of extracting cash from a property company), were also hit in last year’s Summer Budget, making them less attractive.

There are also benefits if you are considering shared ownership. Putting your property in a company can give more flexibility with regards to shared ownership and can be an effective way of deciding who has controlling interests.

Because of the costs of setting up and running a limited company, I would say that if you intend to own five or more properties, a limited company structure begins to become a feasible option, but as always you should seek professional advice that takes into account your specific personal circumstances.

Capital Gains Tax (CGT) is payable on the gain (or profit) made when you sell your property, assuming the individual is a higher rate tax payer, the rate is 28%.

Broadly, everyone’s main home is exempt from CGT when sold, but any other properties owned should be liable to CGT.

If you have lived in your rental property as your main residence you will not be liable for CGT for this period, plus the last 18 months of ownership. In addition, there is the added benefit of being able to claim up to a maximum of £40,000 letting relief. This is available to anyone with a share in the property – giving a couple, for example, up to £80,000 of relief between them.

With regards to trusts and inheritance tax planning, an individual is able to gift a property into trust up to £325,000 without incurring Inheritance Tax, but would be charged at 20% on any amount above this. Any gain can be held over so no CGT becomes due.

After 7 years the gift would fall outside the estate for Inheritance Tax purposes, providing that you are not a beneficiary. The rental income would be taxed at the highest rate (45%).

Trust planning is a complex area and one not particularly tax efficient, so I would recommend that you seek professional advice before making a decision.

When buying your second home the first major tax you will pay is Stamp Duty. As mentioned above, after April 2016 second home purchasers (and buy-to-let investors) will incur an additional 3% on stamp duty on their purchase. As an example, this means that if you purchase a £250,000 second home after April 2016, the Stamp Duty charge will rise by £7,500, a three-fold increase from the £2,500 that you would have incurred before April.

If you choose to rent out your second home you will incur tax on the income you generate from letting it out. You will need to inform HMRC and submit your income through the self-assessment regime. You will also need to keep records of all allowable expenses related to letting out your home so that these can be offset against your tax bill. Your accountant can advise on which expenses are allowable.

When you come to selling or disposing of your property you will be liable for CGT. The government has recently announced that from 2019, those selling buy-to-let property or second homes, will have to pay CGT within 30 days of the sale rather than on the 31st January following the tax year of the sale.

Firstly, it is important to note that private pension funds cannot directly invest in residential property.

However, since 6 April 2015, over 55’s have far greater freedom and are able to use their pension funds as they choose. HMRC treat pension withdrawals as regular income, meaning some basic rate taxpayers could be pushed into the 45% tax bracket if they take out a lump sum which reaches above the £150,000 additional rate limit when added to their other income. Therefore, the big issue with taking out pensions all in one go is the amount of tax you will have to pay on the lump sum.

One of the options is to split your withdrawals, as you are now able to access your pot each year, and most people will be able to take 25% tax-free. Therefore, you could split your withdrawal across consecutive years if it helps you to avoid being pushed into a higher band of tax.

You could also choose to take all of the tax-free cash as income over a number of years (perhaps whilst you are still working), or indeed potentially any combination of taxable and tax-free elements. Certainly, spreading the taxable pension ‘income’ withdrawn over several years would make sense depending on the size on the fund.

In some cases money can be withdrawn from pensions in a manner that does not trigger an income tax charge at all and protects the value against inheritance tax – so you should always obtain proper advice on this before you cash in your pension funds.

You can gift your property to your adult children, however you would incur capital gains tax on any gain made. Also, should your death occur within seven years, the value of the gift would be potentially liable for inheritance tax.

It is also worth considering that if there is a mortgage attached to the property you may be liable for Stamp Duty Land Tax, so again you should always seek the appropriate advice.