Those looking for a safe investment option in the UK quickly turn to property.
Property is a tangible asset that offers a reliable monthly income to supplement your primary career. However, many landlords are not aware of the costs associated with the investment.
Embarking on a property journey without the necessary information can lead to shocking revelations later down the line.
How Do Landlords Make Money?
Investors and landlords make money from property in two distinct ways.
The first is known as rental yield, which balances the monthly rental charge alongside the outgoings associated with the home. The rental yield is presented in a percentage format, and anything above 4% is generally considered excellent.
Furthermore, profit is made by way of capital appreciation (sometimes referred to as capital growth). This is the increase in the property’s value throughout ownership. Many landlords choose to sell their properties to fund their retirement, and the rise in value is often staggering.
Buy-to-Let Stamp Duty
If you already own your home, you will undoubtedly be aware of Stamp Duty Land Tax. It is a tax payable upon purchasing a home in the UK, which varies depending on the value of the property you are purchasing.
However, when purchasing a second property (i.e., a property you do not intend to live in most of the time), you will have to pay an additional 3% surcharge in Stamp Duty Land Tax. As of September 2021, the Stamp Duty rates for second properties are:
3%: £0 – £125,000
5%: £125,001 – £250,000
8%: £250,001 – £925,000
13%: £925,001 – £1,500,000
Income tax is the tax we all pay on our earnings, regardless of whether we are employed or self-employed. Depending on your annual earnings, you need to pay 20%, 40% or 45% of your property profits to the HMRC each year.
Calculating the profit made on a property can be challenging, as the ‘deductible expenses’ must first be taken from the annual revenue. These expenses can include, but are not limited to:
- Gas, water rates and council tax
- Ground rent
- Accountancy fees
- Letting agent charges
- Landlord Insurance
The yearly income from the rental property should first be added to your annual salary. You must then minus the deductible expenses, which will produce your annual income. From here, you will be able to assess which tax band you fall into.
Please note that this figure will vary dramatically depending on your personal circumstances, other investments, and marital status. Working with an independent advisor will ensure your finances are structured in the most tax-efficient way possible.
Where landlords own more than one property, they are permitted to combine all of the rents and expenses associated. This means that expenses can be offset against the rents of other homes, where appropriate. The government is not concerned with which properties are generating specific profits, but is instead interested in your portfolio’s overall revenue.
Capital Gains Tax
Capital Gains Tax is a tax payable when a property is sold in the UK. Main residences generally don’t attract this charge, but it is usually unavoidable with regard to second homes and investment properties.
The rules surrounding Capital Gains Tax are complex and person-specific. As the name suggests, the tax is based on the profit the investment has generated rather than the sale price.
Usually, basic rate taxpayers pay 18% tax on their gains, whereas higher rate payers are subject to a 28% charge. However, these figures can vary dramatically based on the type of property being sold. Capital Gains Tax must be paid within 30 days of the sale of the home.
Forming A Limited Company
Many landlords choose to form a limited company rather than working under their own name. In fact, over 80% of buy-to-let mortgages are now requested under a limited company name, showing just how prominent this structuring is.
The most significant benefit to registering as a limited company is the protection of your personal assets. The limited liability means that the risk associated with investing is much smaller, critical for those less experienced investors.
Moreover, the tax benefits for a limited company compared to an individual are astronomical. The company is taxed at corporation rate rather than income tax rates, and upon sale, the capital gains tax will be significantly less.
Finally, withdrawing money from the asset will be much easier. A limited company opens up the opportunity for dividends, owner loans, and pension pots, which can each be vital when working in the most tax-efficient way.
Failure To Pay
Many landlords are simply not aware of the taxes associated with a second property.
Should you realise your mistakes, you can make a voluntary disclosure through the government’s ‘Let Property Campaign’. There may be fees associated with late payments, yet you can rest assured that your finances are up to date.
If you fail to disclose your income, you may face hefty financial penalties and even criminal prosecution.
Other Fees Involved
There are many other fees associated with investing in property alongside the relevant tax.
First, you will likely be instructing several professionals to handle the day-to-day running of the portfolio, including letting agents and an accountant. Next, the mortgage, landlord insurance and a landlord licence must be considered.
Finally, it is crucial that landlords budget for inevitable void periods. Where the property is empty, the investor will miss out on the monthly revenue and fall responsible for council tax, electricity, and water rates.
How Ross and Partners Can Help
Please note that this article is intended to give you an overview of the tax associated with earnings on rental properties; it is in no way financial advice.
Whether you are new to the world of property investing or have an established portfolio, we will holistically view your financial situation and advise on the most tax-efficient solution.
Ross and Partners are a dedicated team of chartered accountants with over 20 years of experience in the industry. For a no-obligation chat, contact us on 020 8449 0011 or email firstname.lastname@example.org.