Buy-to-let: how much will the tax be?

Figures revealed recently show how fast renting is growing while home ownership shrinks. But what many people switching their cash from poorly performing savings account into property investments don’t realise is how much tax they will pay. Here's our guide

Few would say investing in buy-to-let property is a bad idea at the moment. Every indicator points to a rental market that’s fast expanding, helped by under-supply and ballooning demand.

For example, figures from the Department for Communities and Local Government show the number of privately rented homes has doubled over the past 12 years, one in three homes are now rented and that ‘council’ and private buy-to-let properties are now equal in number.

Rents have also been climbing fast recently and are now five per cent higher than the same time last year, a trend made more severe by the lower number of homes available to rent and demand rising by up to ten per cent.

And to top it all, buy-to-let loans are also increasingly easy to come by after several years of drought. But despite this good news, investors' enthusiasm for buying investment property is often dampened by the tax burden.

Tax on rental income

If you earn income from a property investment then it will be treated as would any other income and taxed at the appropriate rate. So if you are already a 40% income tax rate payer that rate will apply to your rental income as well.

There are some tricks to the trade here. One is that the mortgage interest you pay on your buy-to-let home loan can be legitimately deducted from your tax liability, helping reduce the final bill. One is that, if your family home has a large mortgage and your buy-to-let property a small one, it makes sense to swap this debt around – the more mortgage interest on a mortgage you pay, the less tax.

If this all sounds like tax ‘avoidance’ then you’d be mistaken. This, along with the other expenses you can claim against tax (including wear and tear, cleaning, gardening and letting agent fees) are all condoned as part of a concerted effort by the government to encourage the private rental sector.

You could even say that coalition ministers, keen to keep down the numbers of people who live in directly funded government property (i.e. council houses), are falling over themslves to help property investors.

For example, it was announced during last year’s budget that stamp duty on the purchase of more than one property will be worked out based on the average value of all the properties, not their bulk. So, if you buy a hundred homes worth on average £200,000 you will pay duty at 1% (£200,000) instead of 5% (£1m).

In whose name?

And if you are a couple and are planning to purchase a buy-to-let property and one of you doesn’t earn an income then it’s worth considering putting it in the non-worker's name – as their 'unused' tax allowance will help reduce the overall tax bill.

Capital gains tax

picture of eric picklesTax also applies when you sell (or even give away) a property and it’s not your ‘principal private residence’. Any difference between the purchase value and sold price of such a property is called a ‘capital gain’ and this is taxed at a flat rate of either 18% or 28% depending on your total taxable income. Many people still think capital gains tax (CGT) is charged at 40% and then tapered – i.e. the tax goes down the longer you own the property – but this is no longer true.

What does still remain though is an allowance system. So if you earn less than £37,400 a year then capital gains under £10,800 are exempt, while those over that attract a CGT rate of 18%. If you earn over £37,400 a year then the exemption threshold remains the same but the CGT rate is 28%.

Holiday homes

Properties bought and maintained as second or holiday homes have one advantage over a normal family home – you pay up to 50% less council tax. Eric Pickles (pictured), communities secretary, has been urging councils to scrap this and charge the full rate, but to date 88 authorities still offer the full 50% discount allowed, some 205 have dropped it to a 10% discount while the rest are between the two. Go here to find out which council give discounts.

Capital gains tax applies to holiday homes in the same way it does to buy-to-let properties, and any income earned from renting it out is taxed in the same way too.


    • By Nigel Lewis
      23rd February 2012
    Figures from the Department for Communities and Local Government revealed recently how the number of privately rented homes has doubled over the past 12 years