Buy to Let Taxation Issues (Pre-Budget Statement 0CT 07)

Taxing times ahead for second home owners

The Chancellor’s recent pre-budget statement with particular reference to the changes in Capital Gains Tax has implications for the Buy- to-Let market. This article will revisit the income tax implications of such an investment as well as making you aware of the CGT issues for a Buy to Let investor.

If anyone is considering purchasing a residential buy to let property, they may not be fully aware of the tax implications. Usually there will be two taxes that may have to be paid. These are, income tax, which is payable each year based on their income from the property after deducting certain expenses that have been incurred, and capital gains tax, which is payable when the property is sold and is based on the sale proceeds of the property less the cost of the property.

Income Tax

Usually there will be two types of income that are received from tenants – rent & deposits.

Rent is taxed each year, based on the income that is due during a tax year rather than on the rent that is actually received during the year. For example, if a tenant pays in advance, only that part which falls within the tax year will be taxed in that year. The remainder will be taxed in the following tax year. Similarly, if a tenant is late in paying, that part which was payable in the earlier tax year will still be taxed in that year. The only exception to this is when a tenant defaults on a payment and the investor will not be able to recover the amount due.

Deposits are not taxable whilst they are still repayable to the tenant, but once either part or all of the deposit ceases to become repayable, such as because there has been damage to the property, then this will become taxable at this point.

There will be various expenses that you will incur on your property: those that you can offset against your rental income (allowable expenses) and those that you cannot offset against your rental income (disallowable expenses). The more usual items are listed below:

Allowable Expenses help lower your tax bill

• Advertising the property for let
• Repairs to the property and general maintenance costs
• Cost of services provided to your tenants, such as utilities
• Managing agents fees
• Insuring the building and contents
• Interest paid on any loan taken out to buy the property

Disallowable

• Renovation work and improvements made to the property, such as replacing an item with a one of a higher specification, installing central heating, carrying out any work which was accounted for by a reduced purchased price for the property
• Capital repaid on any loan taken out to buy the property
• Costs incurred whilst the property is not available for letting
• Costs of purchasing/selling the property

These lists are not exhaustive and it would therefore be recommended that any individual seek advice regarding any expenditure incurred from their local inspector of taxes to ensure that they obtain any tax relief available.

Administration

You are required to complete a personal tax return and pay your tax liability for each tax year once your letting has started, even if you do not already receive a form from the Inland Revenue. The Inland Revenue charges penalties where the Tax Return is submitted late and interest where the tax is paid late.

Capital Gains Tax

The gain that is subject to tax is the proceeds that you receive from the sale less the price that you paid for the property. These costs will include your costs of purchasing and selling the property, such as legal expenses, estate agents fees and stamp duty. If you have carried out any improvements to the property, including renovation work and these costs have not qualified for relief under the income tax rules then you may be able to get relief for these expenses now.

Legacy CGT Issues

As a result of the Pre-Budget statement, from 6th April 2008, indexation relief will no longer be available. This applied any increase to the retail price index on the initial purchase price having the effect of stripping out any inflationary gain. This was known as Indexation Relief.

A tapering tax relief used to apply the longer a property was held. This relief was applied from the 3rd year of ownership, with a 5% discount deducted for each additional year from the taxable gain up to a maximum of 40%. Again, as a result of the Pre-Budget statement, taper relief will no longer be available with effect from 6th April 2008.

From 6th April the single rate of CGT reduces to 18%!

If there was any good news in the pre-budget Statement for buy to let investors it was this. From 6th April 2008, there will be a single rate of Capital Gains Tax of 18%. So, for higher rate taxpayers who would have paid 40% tax, when realising an asset, this is to be welcomed. However, the “downside” is that with the absence (from 6th April of April 2008) of indexation relief and taper relief, investors will be paying 18% tax on a much larger gain.

However, the CGT annual exemption is to be retained and for tax year 2007/08 this amounts to £9,200 per individual. So, if a couple own a property jointly, they will have £18,400 to be utilised before assessing if any gain has in fact been realised.

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