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Residential property letting – let’s talk tax!

One of the areas clients often ask me about is the taxation aspects of residential property letting:

“Should I invest personally or through a company?” 

“How do I calculate the letting profits and expenses that can be claimed?”

“What are the tax implications when I sell the property?”

In the July ’15 budget, a couple of significant changes came into play so it’s worth taking a look at the key facts:

It’s taxable!

It’s probably a fairly obvious point but the profits from letting are taxable. There’s a need to notify the Revenue of the letting and, in most cases, this will lead to the requirement to file tax returns.

I have to say that in my experience the reporting by taxpayers of residential property letting is one of the main areas of non-compliance that I encounter. It’s all too easy to start letting, perhaps simply a former main residence that has been retained by the owner, and overlook the need to deal with the taxation obligations. It isn’t worth it – the Revenue get better all of the time at catching up with defaulters.

As a landlord you will need to notify HMRC by October 5th following the first year of letting – probably best by phone initially, or you can complete an SA1 form online. Usually, the end result is that you’ll need to do annual tax returns.

If you have been letting for some time under the HMRC radar, then you could make a disclosure to them under their let property campaign – designed to flush out defaulters by offering low penalties.

 Companies vs personal ownership

Small scale residential investment is usually done as an individual rather than using a company, because:

  • Investors will usually want to avoid the costs and administrative bother that goes with running a company
  • If it’s a former personal residence the property will already be owned personally and the owner will want to enjoy some degree of exemption on the end disposal of the property, due to Capital Gains Tax main residence relief.

Using a company

The costs of running a company make more sense when it’s a bigger enterprise, because:

  • You can avoid drawing income personally – so there’s only 20% Corporation Tax (now reducing to 18% over the next few years)
  • There’s Limited liability for the owners – probably not a major consideration (more of an issue for businesses with risky transactions, or, perhaps, dangerous machinery or heavy vehicles)
  • Admin: filing accounts and Corporation Tax returns etc.
  • ATED returns – required now for properties in companies when they have a value of more than £1 million – next year the return is needed for properties valued > £500K

There are a few changes and proposals in the recent budget that may encourage the use of companies:

  • There will be future reductions to the Corporation Tax rate. We already have a relatively low rate of 20% – that’s reducing to 18% in a couple of steps. We’ll have the 18% rate in 2020.
  • A proposal to allow buy to let mortgage interest only at the basic rate of tax. Possibly we will have this from 6.4.17. Higher rate taxpayers will certainly wonder whether letting via a company is a better bet.
  • There’s also a change for the worse regarding companies: there will be increased taxes on dividend payments from April 2016 (and dividends are probably the most popular way of extracting income from a company). Not a problem, though, if you don’t plan to draw income from your company.

Calculating the taxable profit

 The first point is the need to keep records.  It doesn’t have to be too sophisticated unless it’s a big or a corporate letting concern – a file of receipts and an excel spreadsheet will usually do.

The income side is usually very easy to identify – it’s more a question of knowing what costs can be claimed.

As a broad rule the costs incurred in running the let property can be claimed as a deduction against the letting income, but the capital cost of the building cannot (i.e. the property purchase price, the cost of any structural changes or extensions etc.).

The sort of costs that can be claimed as deductions are:

  • Decoration and repairs
  • Rent/ground rent that you pay
  • Managing agent fees
  • The legal costs for short lease renewals
  • Interest on mortgages to fund the cost of the property (but note possible new rules)
  • Insurance
  • Gas safety certificates etc.

There are a few areas with particular considerations:

Relief for assets and renewals.

This has traditionally been a difficult area. Generally the existing rules are that claims are made:

  • For replacement items when they are incorporated into the building (kitchen units etc.)
  • For replacement items of small value (crockery or rugs for example)

And for furnished lettings:

  • A wear and tear allowance of 10% of rental income to allow for the ongoing cost of furnishings, carpets etc. (Note this has always been a valued relief and, going back a couple of years when it was possible to claim relief on a replacement basis as an alternative, taxpayers rarely took advantage of this because wear and tear is more beneficial.)
  • Some assets, however, fail to get relief (for example, free standing items such as fridge freezers).

Budget changes

Again, the recent budget has announced changes that affect the current rules – from April 2016 the wear and tear allowance will be replaced with a new relief that will allow relief for furnishings on a replacement basis. The details will be announced after a consultation process. Although it’s disappointing to see the 10% wear and tear allowance go, the upside is that we expect the new replacement basis to bring in relief for items such as freezers and televisions.

Relief for mortgage interest

This is another area for which changes were proposed in the recent budget, the introduction and details being subject to a consultation process.

It is proposed that relief for mortgage interest will be restricted to the basic rate of tax – this restriction being phased in from 2017/18 onwards.

I personally don’t think this is something that is necessarily fair from a taxation point of view – I think we have to accept it is probably a measure that is designed to dampen demand for buy to let properties, where investors are competing with prospective homeowners for housing – a resource for which there is limited availability.

This could have the effect that higher rate taxpayers pay tax on a profit they don’t make. As I mentioned before, investors in this situation will wonder if the use of a company is the way forward.

Losses

Losses cannot be offset against other types of income. They have to be carried forward to set against future letting profits.

Capital Gains on sale

A common reason for going into buy to let is the long term capital gain – for individuals the gain on a standard buy to let property is taxed at 18% or 28% (depending on how much of the gain falls into the higher rates).  Individuals also have an annual exemption to set against gains (currently £11,100).

As I mentioned before, if it’s a former main residence then main residence relief (and related letting relief) should also be available to some extent.

Other letting issues

Holiday letting: has different rules – it’s treated as a trade.

Foreign lets: profits are calculated in the same way as for UK property lets but the reporting goes on the foreign pages of the tax return, and losses are ring-fenced for foreign lets only.

Stamp duty: some reform this year but it’s still expensive!

It’s clear that a lot of different rules come into play when letting a residential property. If you’d like more detail on anything that’s covered here, please do get in touch on 020 8652 2450 or via email at crg@clarksonhyde.com

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