When purchasing property, effective tax planning is essential. With the support of an independent financial adviser, you should consider different tax reliefs to design a personalised, long-term plan to minimise the amount of tax you pay.
Most property purchases are liable for Stamp Duty Land Tax (SDLT). This is a percentage tax paid on the purchase price of your property, which differs depending on whether the property is your main home or a buy-to-let investment. Similarly, properties are liable for Council Tax, with the amount depending on various factors such as property size and location.
With taxes such as Property Income Tax, Capital Gains Tax (CGT) and Inheritance Tax,reliefs are available. Utilising these can increase your tax efficiency.
What is Property Income Tax?
If you are a landlord or if you have purchased a buy-to-let property, you will be taxed on rental income from tenants.
This can count towards your taxable income, which could result in a higher tax bracket, which creates a higher percentage Capital Gains Tax when the property is sold.
What is an offset buy-to-let mortgage?
From April 2020, you can no longer offset mortgage interest payments against property income to reduce your mortgage interest tax. An offset buy-to-let mortgage is a new alternative.
You can leave the property income in this account, which gets offset against the mortgage to reduce the interest. The less interest paid on the mortgage, the higher the profit on the property.
Offsetting allowable expenses against property income will increase your tax efficiency. These expenses include:
- Property maintenance, repair costs
- Replacing furnishings (e.g. white goods)
- Leasehold ground rents
- Letting agency fees
- Cleaners’ or gardeners’ wages
- Insurance costs
Allowable expenses are always changing. Our financial advisers can identify your present offsetable costs and examine the full property portfolio to ensure you are not paying any unnecessary tax. Be sure to keep any receipts or records to validate your claims.
It can be tax efficient to gift a property to your spouse, especially if they fall into a lower income tax band. This can significantly reduce tax on rental income. If it is their only source of income, it can even eliminate this tax.
For more information, we advise speaking to one of our independent financial advisers, who can advise on the best route when gifting property.
Setting up a Limited Company
Do you rent out multiple properties? If so, setting up a limited company could help minimise your tax outgoings. Through a limited company, you can:
- Hold and purchase properties
- Sell your existing properties to the company to avoid individual taxation, although you may incur Stamp Duty and CGT in the process.
As previously mentioned, from April 2020 you are no longer able to deduct mortgage interest costs from income tax. However, this does not apply to limited company landlords. Individual property investors with a limited company can deduct mortgage interest costs from rental income before corporation tax is calculated. Corporation tax dropped to 19% in 2020, thereby lower than individual income tax for higher-rate taxpayers.
What is Capital Gains Tax (CGT)?
If you ever want to sell any of your properties, you may have to pay Capital Gains Tax (CGT) on the value increase. The percentage of CGT you are liable for varies depending on:
- Whether the property is your main residence, or a second home or buy-to-let investment.
- Your taxable income: CGT is 18% for the basic tax bracket (£50,000 or less annually) and 28% for the higher tax bracket (£50,001 or more).
How does Capital Gains Tax (CGT) affect a main residence?
When it comes to selling, the CGT will be covered by Private Residency Relief (PRR). Provided the property has been your main residence over the entire period of ownership. However, you may be liable for CGT on your main residence if you:
- Rented out the property, in either part or full (excluding a single lodger)
- Bought the property with the purpose of renovation to sell
- Have development plans (e.g. turning the property into flats)
- Use part of your home for business purposes
- Moved out of the property over 9 months ago
How does Capital Gains Tax (CGT) affect a second residence?
When selling a second property, you have an Annual CGT Personal Allowance of £12,300. This can be deducted from your property’s taxable gains to reduce your CGT.
If you are a married couple, you have the option of combining your annual CGT allowances, meaning you can deduct £24,600 from your taxable gains to reduce your CGT. Also, if the sale of your second property is at a loss, these losses can be offset against your capital gains tax for the following four years.
When buying a second home, only one property can be nominated as your main residence. Changing this is known as the flipping process, which must be done within two years of getting a new property. For each year that a property is nominated as your main residence, and 9 months prior to sale completion, you have tax-free capital gains covered by Private Residency Relief (PRR).
An independent financial adviser can help you to select the property expected to have the largest value increase, which will help you minimise the total CGT you pay on your properties.
As a married couple, you can only select one main residence between you. It is important that the property is actually your main residence, as you may be required to provide proof (e.g. bills, bank statements, evidence of your name on electoral register). Also, you must ensure that there are no contradictions (e.g. different addresses linked to self-assessment tax account).
How can you minimise Capital Gains Tax (CGT) on a buy-to-let property?
Although buy-to-let property owners are also eligible for Annual CGT Personal Allowance, there are additional CGT reliefs, such as letting relief and offsetting costs.
Letting relief can reduce your CGT by up to £40,000, providing that the rented property was also your main residence. To qualify for 2020-21 tax returns, you must live in shared occupancy with your tenant. So, in most cases, you will already qualify for PRR.
As you can’t claim private residence relief and letting relief for the same period, the claimable amount is the lowest of:
- Profit gain from letting to tenant
- Claimable Private Residency Relief (PRR)
Offsetting your costs reduces your CGT by deducting certain expenses from the taxable gain. This includes:
- Estate agents’ and solicitors’ fees
- Stamp Duty paid on purchase
- Surveying and valuation costs
- Property improvement costs (e.g. an extension)
Speaking to one of our financial advisers can help you identify which relief is most tax efficient, and which of your costs are offsetable.
How can you minimise inheritance tax when purchasing property?
Your family will be liable for inheritance tax on gifted properties or those claimed through your death. It’s important, however, to remember that the property may also be liable for CGT if it is sold without being your main residence.
By consulting with your financial adviser, you can discuss the best options for reducing this tax.
KLO Financial Services
There are many tax implications to purchasing a property. At KLO Financial Services, our expert independent financial advisers can help you keep your tax to a minimum while increasing your property investment profits.
Call us on 01926 492 406 to find out more.