Tax

1.6 Tax

Tax is an aspect of residential property investment which is often
overlooked. There are many twists and turns to consider at all levels,
whether it be for income tax, capital gains tax or inheritance tax, and it is
important to get the structure of ownership right and to make sure that all
tax relief, allowances and claims are made.

This section summarises some of the main aspects of the principal areas
of property tax. There are many detailed aspects to consider at each stage,
and it is very important to obtain good professional advice if there are any
doubts as to the applicability of any rule. Tax decisions can be influenced
by what other income and assets the tax payer has and will not necessarily
be the same for every property investor.

All areas of tax require the practise of good record-keeping (this is equally
applicable when a property is sold). It is essential that full and accurate
records are kept of all income and expenditure, perhaps maintaining a
separate bank account for these, so that all of the information is readily
available to allow the tax payer to claim the maximum deductions and pay
the minimum amount of tax. Failure to keep adequate records can result in
penalties.

1.6.1 Income Tax

If the landlord is a new property investor HM Revenue & Customs (HMRC)
should be notified immediately of the new source of income which the
landlord is now receiving. The tax is computed through an annual tax return
sent to HMRC.

Income tax is payable on profits made from the property-renting business
by computing the total of rents receivable less expenses. Tenants’ deposits
do not count as income. Typical expenses which can be deducted include:

• repairs and maintenance (though not initial expenditure needed to bring the property up to a letting standard, or improvements);
• gardening;
• cleaning;
• ground rents;
• service charges;
• contents and building insurance;
• managing agent’s fees;
• legal fees for tenancy agreements;
• advertising;
• HMO licence costs;
• interest (not the capital repayments) on loans used to buy or
improve the property;
• water rates;
• council tax;
• heating;
• lighting;
• security;
• accountancy fees;
• subscription to a landlord’s association; motor and travelling
expenses for visiting the property and for attending to matters
relating to let properties.

A special wear and tear allowance of approximately 10% of the rents
received can be claimed if the property is let furnished.

This list is not exhaustive and can vary in individual circumstances.

A special tax allowance exists if the landlord undertakes certain
improvements to the property to increase energy efficiency, known as the
Landlords’ Energy Saving Allowance (LESA). Further details can be obtained
from www.hmrc.gov.uk/manuals/pimmanual/PIM2072.htm

On the question of repairs and maintenance, it is important to distinguish
between items of repair and items of improvement. Redecorating rooms,
changing windows from single to double-glazing, or replacing a defective
roof are examples of repairs which will be allowable. The addition of
another floor to the building, or a new conservatory would not qualify
and tax relief would only be received on the eventual sale of the property,
being set against the eventual capital gain.

1.6.2 Structure

Where properties are owned in joint names, then the profits can be shared
between the joint owners or, in certain circumstances, can be wholly
attributable to one or other of the joint owners.

Where a husband and wife own a property jointly, the income is
automatically assessed equally, even if the actual ownership proportion is
not equal, unless they elect otherwise.

For capital gains tax purposes, the proportionate ownership is important,
and any capital gain would be shared between the joint owners in their
respective proportions giving rise to multiple tax-free allowances.

In certain circumstances, it may be worthwhile for a limited company to
be brought into the structure. It is normally sensible for the properties
themselves to be held in individual or joint names, but these can be sublet
to a company who then lets the properties to tenants. Professional advice
should be sought to look at the best structure for any given landlord to use to own investment properties.

1.6.3 Capital Gains Tax

Capital Gains Tax (CGT) is a tax on the gain or profit made when shares or
property are sold, given away or otherwise disposed of. There is a tax-free
allowance and some additional reliefs that can reduce a Capital Gains Tax
bill

Capital gains tax is one of the most important taxes to consider as property
prices will usually rise over the long term. As the amounts at stake are
potentially significant, it is important to make sure that all of the available
tax relief and allowances are taken advantage of. Many of these offer scope
for substantial reductions in the ultimate amount of tax to be paid.
The basic concept is quite simple: the final price received for the property
when it is sold (after deducting legal costs and agent’s fees) is compared
with what the property cost initially (including any legal fees and stamp
duty), and the profit, or “gain” is calculated on which tax is levied.

There are then potential deductions and tax relief available, the most
important of which are as follows:

• the cost of any improvements to the property whilst under
ownership can be deducted (but not the cost of repairs that
has previously been set off against income tax);

• if the property has been occupied by the owner as an owner-
occupier at any time, then there are two additional very
valuable reliefs:
- lettings relief whereby up to a certain amount of any gain
per owner can be tax free
- a proportionate principal private residence relief;

• if the property was owned at March 1982 its value at that
date is substituted for the original cost of the property in
calculating the ultimate gain;

• set value of any capital gains in a single tax year is tax free per
individual (not per property), tax only being charged on any
gain above that value;

• if there are two properties which have been used as a
residence (e.g. one in London and one in the country), it is
worthwhile making a principal private residence election
on one of those properties to maximise capital gains relief.
This will also reduce the potential CGT payable if one of the
properties is let at any time in its ownership.

1.6.4 Inheritance Tax

Where a property is owned at the date of death, the value of that property
forms part of the estate and is potentially liable to inheritance tax (IHT). If
the property is left to a spouse in a will, then no IHT would be payable until
the death of the spouse.

There are ways of reducing the Inheritance Tax liability. A tax efficient will
should be drawn up to ensure maximum use of IHT allowances.

Wills and trusts are specialist areas where it is important to obtain
professional advice. Advice will vary depending on the individual’s
circumstances.

1.6.5 Stamp Duty

Stamp Duty Land Tax (SDLT) is payable by the purchaser within 30 days of
the purchase, so this should be taken into account when budgeting for a
purchase. No Stamp Duty is payable below the prevailing threshold, but
above the nil-rate threshold the applicable rate of SDLT will depend upon
the price paid. There are reliefs available in ‘disadvantaged areas’ – but
these only apply to the lower value properties in those areas. The list of
disadvantaged areas is much longer than one would imagine, so it is always
worth checking to see whether relief is available. Go to www.hmrc.gov.uk
and search for ‘Postcode Search Tool’ to see if a property could qualify.

The value of any fixtures, fittings or furniture included in the purchase can
be excluded from the purchase price in calculating the Stamp Duty payable,
though the Stamp Duty Office will look at any obvious overloading.

1.6.6 Value Added Tax

Under normal circumstances, landlords cannot register for value added tax
(VAT) in relation to their residential properties, as residential rental income
is exempt from VAT. This means that any VAT incurred cannot be reclaimed.
However, landlords who are VAT registered in their own self-employed
businesses may be able to claim some VAT incurred.

A special VAT rate of 5% is available on the renovation or alteration of
a single household dwelling that has not been lived in for three years or
more, so that this is a useful saving over the normal 17.5 per cent rate.

More information on tax can be obtained from a local tax office or visit HM
Revenue & Customs website at www.hmrc.gov.uk. Copies of leaflets on
taxation of rents and other tax matters can be downloaded from HMRC’s
website, or can be requested by phoning the Order Line on 08459 000 404.