They say that buying or selling a property is one of the most stressful things you can do in life. And renting out a property also brings its own workload. So perhaps it is no surprise that so many clients I talk to have already received advice from solicitors, plumbers or surveyors – but they have forgotten to speak to an accountant! And yet, no matter what stage you are at in your housing investment journey, your tax situation could well be key to whether your hard-earned money delivers a profit or loss at the end of the day.
I know it can be complicated, and there often seem so many different taxes that might or might not be due – but that’s why when Tay Lettings asked me write this blog I decided I’d share with you a scenario, and outline briefly the things this imaginary couple may need to consider during their journey of buying, renting and then selling a property. It is only a short blog, so I can’t go into all the details, but if you would like to learn more we have a free download available on the French Duncan website which goes into more – CLICK HERE. Or you can get in touch with me directly via email and I would be happy to arrange a chat (E: email@example.com, T: 0141 271 3941).
Scenario – The new rental property
Let’s assume Mr A and Mrs B are married, Scottish higher rate taxpayers paying income tax at the 41% rate and are purchasing a property in Scotland for £200,000. And it’s the first of what might be more rental properties.
Phase 1 – Purchasing the property
The first thing to consider is structuring the purchase – i.e. who will actually ‘own’ the property, and in what percentage terms. Why does it matter? Well this initial structure can impact all sorts of future tax implications, like who ‘profits’ each year and therefore what tax bracket they fall into, and who it is who finally ‘sells’ or ‘gifts’ the property and therefore what tax is due at that point too. But it’s not always as simple as that either, because how you structure ownership may also impact borrowing potential, and can even impact any future divorce settlement between couples (if that were to happen). And sometimes buying via a Partnership or a Company can make sense too – so as I say, lots to consider.
In our scenario, the first tax to be due however will be the Land & Buildings Transaction Tax (LBTT) – payable based on the ‘slab’ system – and as it’s a second property also the Additional Dwelling Supplement (ADS) charge at a flat rate of 4% the purchase price. So the ADS can be a significant additional cost, and remember it needs to be paid within 30 days of the property purchase.
Obviously buying a property doesn’t incur Inheritance Tax (IHT), but the property will become a part of the Estate of Mr A and Mrs B for IHT purposes. Depending upon the other assets in their Estates, there may be an IHT exposure at a rate of 40% on the excess value – and if the property increases in value and as any mortgage is paid off the capital value will increase so thought should be given to how this value is protected from a potential IHT charge (again, perhaps via the initial ownership structure?).
Phase 2 – Operating the rental business
Once Mr A and Mrs B start receiving income from renting the property, they will be assessed for income tax on their profits – basically rental income less certain ‘allowable’ expenses…but they key word there is ‘allowable’.
In essence, there are three categories of expenses which are likely to be incurred on a rental property:
Revenue expenses – These can be offset against the profits, but only if ‘wholly and exclusively for business purposes, and not of a capital nature. So agent fees, insurance, council tax, and mortgage interest (subject to the below) yes. But your computer to communicate with the agents or ‘home office’ space, NO! Repair costs then get a little more complicated, as it depends on the specifics and they can be offset against either revenue or capital expenses.
Capital expenses ‘allowable’ – This is things like a new extension, the costs of which don’t impact your year-to-year taxable profit, but they can be offset against a potential chargeable gain on a future sale or gift – so it’s still important to keep records of all these.
Capital expenses ‘unallowable’ – Some capital expenses don’t bring any tax relief, such as capital repayments towards a mortgage.
So, as I say, rental profits (income minus revenue expenses) generated from property will be assessable to income tax – in our scenario at 41% for both Mr A and Mrs B even if these profits are not withdrawn from the ‘business’. Given that both Mr A and Mrs B are higher rate taxpayers, there will also be a restriction on the amount of interest paid that can qualify for income tax relief. These rules are quite involved and interest relief can be wholly restricted, e.g. if there are high repairs in a particular year but, generally, interest relief should be available at the basic rate. It is worth noting that this restriction does not apply to qualifying Furnished Holiday Lets or purchases made through a Company (assuming this is straight forward) – but in both those cases you should definitely seek further advice.
Phase 3 – Selling or gifting the property
If Mr A and Mrs B decide to sell the property on the open market then it’s a relatively simple case of Capital Gains Tax (CGT) potentially being due. Although I say ‘relatively’, as to determine what that CGT cost should be we will need to look back at the purchase price, costs (some costs) incurred both capital and sales agents etc., any time spent living in the property and of course the annual exemptions available per individual. But overall, if there is still an outstanding ‘gain’, given they are both higher rate taxpayers, CGT at a rate of 28% (but this could be higher in the future) would be payable on this. And remember, the CGT and the CGT Property Return MUST now be paid/filed with HMRC within 30 days of the sale completing!
If, however, Mr A and Mrs B decide to gift the property, for example to their children, then this will impact another CGT cost, LBTT cost (if the mortgage is still outstanding), potential Inheritance Tax implications and more. Again, further information can be found in our downloadable document by clicking here.
As I’ve outlined above, in this scenario there are quite a few points for Mr A and Mrs B to consider before buying, whilst renting and then when selling. Sorry, I know it’s complicated – but my key piece of advice is to speak to a professional BEFORE making any decisions about property. Whilst I know “I would say that”, every situation is unique – but if we speak to you early enough I’m sure we can help save you money in the long-run.