Back to Basics: Buy-to-let property and tax interaction
Using the practical example of a buy-to-let property is a great way to see the interaction of taxes that are studied at TC and TPS levels. In this short article, we remind you of the key tax points relating to an individual with a buy-to-let property.
You’ll find reference to several different types of tax in this article – try to see the big picture and not just focus on income tax.
Purchase of property
Let’s imagine you’ve inherited a sizeable sum of cash (on which there may have been inheritance tax payable!) and plan to invest it in a buy-to-let property. First up, you’ll have to buy it.
The good news is that there is no VAT on residential property as the purchase is either zero-rated if it is a new build, or exempt.
However, you may have to pay SDLT, or LBTT, depending on where the property is situated and how much it costs. If you’re purchasing a second (or third, or fourth) property there will be a premium of 3% SDLT/LBTT, if the property cost exceeds £40,000.
Getting the property ready
Now you’ve bought the property you may want to modernise it and purchase some furniture. The key is to ensure that you track all expenditure, as some of it may be deductible against the income that you will earn when the property is let out.
Not all expenses are deductible; the main distinction is whether or not the expenditure is capital (creating or improving an asset) or revenue (maintaining it).
If the expenditure is capital, you can’t deduct the cost against your income. You may be entitled to capital allowances, but not in relation to furniture or fittings in a residential property.
However, capital allowances are available for the purchase of assets you use to run your property business (perhaps tools, a laptop or a van).
Whilst you are not permitted capital allowances on furniture, you may be able to claim a deduction for the cost of replacing furniture later. Any capital costs which do not qualify for allowances may still be tax deductible if you come to sell the property (see 'Sale of Property', below).
Letting it out
Rental income is subject to income tax, and if you don’t currently complete a tax return, you would have to request one from HMRC (by ‘notifying chargeability’ to income tax). Failure to do so could lead to penalties.
Rental income is taxed via the self-assessment system and can result in a taxpayer having to make payments on account. There is no national insurance on rental income as it is not income from a trade or profession.
As a landlord, you’ll be taxed on the rental income receivable for a fiscal year (irrespective of whether or not you actually receive it). You can offset allowable costs of running the rental business against this. Typical costs will be mortgage interest, advertising for tenants, cleaning and repairs.
You may also have capital allowances on assets used to run the business and deductions for replacement furniture.
Sale of property
You may decide to sell the property at some point in future. This will trigger a chargeable gain, assuming it has increased in value.
As the property is not your main home (your ‘principal private residence’) it won’t be exempt. In addition, residential properties attract higher CGT rates than other assets, so you’ll pay tax at either 18% or 28% (rather than the standard rates of 10% and 20%). The gain is calculated taking the proceeds less purchase cost.
You can also take account of any legal fees on purchase or sale and any capital expenditure on enhancing the property. The SDLT/LBTT paid on purchase is part of the purchase cost and hence deductible.
- Renting a room in your own house? You may benefit from rent-a-room relief; reducing or eliminating the taxable income.
- Renting property as holiday accommodation? If you meet the conditions of FHL (furnished holiday lettings) then there are a number of tax benefits, including the availability of capital allowances on furniture and entrepreneurs’ relief on capital gains.
Property income affects individuals and companies and is examined throughout all levels of the CA and ITP qualifications.