Buy-To-Let Property Investment
Traditionally the prospect of capital growth drives Buy-To-Let property investment. Rental income from tenants is used to cover mortgage and any other on-going costs associated with managing and maintaining the property.
However, due to recent market climate, investing in Buy-To-Let property also generates appeal from investors looking for both income return as well as capital growth. With a perception of lower risk over the longer term.
This is principally a combination of two current market factors:
- A prolonged outlook of low percentage rates of return on cash or other lower risk securities such as bonds or gilts.
- A reluctance to compensate for low income returns by investing in higher yield but higher risk alternatives such as equities.
After the global crash in 2008, equity markets have been demonstrating significant volatility. Additionally there has been a considerable loss of trust by the public in the reliability of pension funds as a means of saving for retirement. As a result, Buy-To-Let property investment has increased significantly due to the dual attraction of perceived lower risk and history of reasonable returns.
The Buy-To-Let property market
Although the local Buy-To-Let property market behavior is cyclical, it has proven to be a very successful investment over the long-term. Consequently, recognition of this performance combined with the current housing shortage and market climate has driven huge growth in the Buy-To-Let sector.
However, government legislation is changing with the intention of slowing down expansion in the Buy-To-Let property sector. This is partly in response to the pace of growth, housing availability, political will and also macro economic policy. Therefore gross returns (rental income minus costs such as letting fees, service charges, insurance and annual maintenance) are not quite as high as they once were. Prospective investors need to be aware that capital appreciation should meet or exceed inflation over the holding period. Furthermore they should also look closely at their cost profiles and tax position.
Key factors to bear in mind:
- Consider any investment as a medium to long-term proposition.
- Research the local market to find the right investment property.
- Work out your budget and factor in all costs precisely.
- Ensure your property is decorated and fitted to a good standard to attract tenants quickly.
- Invest in anything which has a history or potential of maintenance problems.
- Assume that you, your friends or relatives can manage the property. Unless you’re a hands-on investor with lots of time you’re probably better off with a full property management service.
- Cut corners regarding tenancy agreements and other legal processes or documentation.
Finding the right investment property?
The perspective for making a Buy-To-Let property investment is very different from buying your own home. It may be useful for you to have a local letting agent advise you on the rental property market. A good agent automatically knows where potential for capital growth and income potential sits and will also be able to provide a detailed justification for any property valuation they give you. Kings & Co in particular prefer to work at the beginning of the process where we establish a detailed client profile and execute an on-going property search to find the ideal match.
Property Management Agents
Buy-To-Let property management requires more “hands-on” involvement than most people realize. Aside from the initial set-up, tenants have on-going service expectations and can at times be very demanding. For example, trying to sort out a plumber on a Sunday morning is not most people’s idea of fun, especially if you live a good distance from your property. For this reason, Kings & Co lettings operate a 24 hour emergency hot-line which is available to all managed tenants.
An agent will also advertise the property for you and show prospective tenants around. This can also be done yourself if you have the time and organization.
Letting agents will also be able to recommend the right presentation and condition of your property. If the property is to be furnished, a letting agent will also be able to advise you of the standard of decoration and furnishings which is expected to be able to rent your property quickly.
Lastly, an agent will ensure that you are compliant on an on-going basis with all legal regulations in letting your property, again this saves client time and the need to constantly check and update your status.
The tenancy agreement is an important document and is there to make the legal position clear.
Buy-To-Let property investment taxation
You should consider your tax position carefully before you invest in Buy-To-Let property, paying particular attention to the taxation changes tapering in annually up and until FY 2020 (see below). Due to this, it is important to structure your investment to perform as tax efficiently as possible. For example, if your spouse is in a lower tax bracket then transfer of property ownership and income distribution may benefit you. Or alternatively if you have a large portfolio or have no headroom in terms of tax bracket, then re-structuring your portfolio inside a limited company may provide better overall efficiency.
Buy-To-Let property tax on rental income
After deducting allowable expenses, income tax will be due on the rents received. Allowed expenses include repairs, mortgage interest (see below), fees from the letting agent and furnishing allowances.
Loan interest relief is being restricted for Buy-To-Let property landlords
There is a government plan initiated which will ultimately lower the level of income tax relief landlords can claim against their financing cost down to basic income tax rates. These financing costs include fees charged when setting up or paying off mortgages or loans, interest on any loans used to furnish a property and mortgage interest. Capital repayments on a mortgage or loan attract no tax relief.
Going forward landlords will not be able to deduct 100% of financing costs from property income. Instead, they will receive basic rate reduction only from their income tax liability. The government plans to taper in the implementation of this change over four years, starting from April 2017, in order to allow landlords to adjust and prepare.
The phasing on relief restriction is as follows:
- 2017/18 – Deductions from property income are restricted to 75% of financing costs with the remaining 25% available at the basic rate
- 2018/19 – Deductions from property income are restricted to 50% of financing costs with the remaining 50% available at the basic rate.
- 2019/20 – Deductions from property income are restricted to 25% of financing costs with the remaining 75% available at the basic rate.
- 2020/21 – 100% of all financing costs incurred attract basic rate tax relief only.
Wear and tear allowance will be replaced in 2016/2017 tax year
After 1st April 2016 (Corporation tax) and 6th April 2016 (Income tax), the long established “wear and tear” allowance for fully furnished properties is being replaced by a new scheme. The new scheme applies to all residential property whether fully furnished, part-furnished or unfurnished and allows the landlord to deduct the actual costs incurred to replace kitchenware, appliances and furnishings.
The wider scope of this new measure enables cost of furnishing relief to a broader range of property businesses. This is because the “wear and tear” allowance previously only allowed relief on fully furnished properties.
Eligible capital expenditure examples are:
- Appliances (including white goods)
but would exclude items which are fixtures.
If there is any improvement on an old item, the relief is limited to the cost of an equivalent replacement of the old item only. Additionally the deduction cannot be used where relief is claimed under rent-a-room status.
Buy-To-Let property tax on sale
On the eventual sales of the property, Capital gains tax (CGT) will be payable. CGT is charged on the property disposal proceeds minus the original property cost, certain legal costs and capital improvements that have been made to the property. There is further possibility to reduce the chargeable gain by using any annual exemption available. The remainder is then taxed at either 18% or 28%, or depending on your income position could also be a combination of both rates.
CGT rates reduced as of 6th April 2016 down from 28% to 20% for the higher rate and down from 18% to 10% for the basic rate. However, for residential properties that do not qualify for private residence relief (usually any property that is not your own home), these reductions do not apply and rates remain at 28% and 18% respectively for all chargeable gains.
CGT is due the 31st January following the end of the tax year in which any gain was made.
From April 2019, upon disposal of residential property, a payment on account for any CGT due will be required to be made within 30 days of the completion of that disposal. Properties which qualify for private residence relief are by default not liable for CGT and are unaffected.
If you have children either currently studying at college or university or planning to do so, then Buy-To-Let property investment may make sense to support them through this period. If this is a likely proposition then consideration of the structure of this arrangement is important. The parent should act as guarantor on the mortgage and the student themselves should purchase the property.
This type of arrangement delivers several benefits:
- A cost effective method of providing your child a quality residential property of your choice.
- From a cash flow perspective mortgage repayments could potentially be covered by rental income generated by letting spare rooms to other students
- The property should be exempt from CGT providing it is the child’s only property as it will be regarded as their main residence at point of sale.
- A deduction known as “rent-a-room-relief” reduces the amount of rental income that becomes chargeable to income tax. As of 6th April 2016, rent-a-room-relief is £7,500 per annum, no other expenses are tax deductible. Rent-a-room-relief can also be replaced by normal letting rules where expenses can be deducted from income if is perceived to be more efficient.
How can we help?
Tax planning is an important element of any Buy-To-Let property investment decision and the information above is intended to provide a general basis of understanding. Every individual’s investment situation is different, therefore it is necessary to tailor advice accordingly in close alignment with client circumstance and aspirations.
If you are looking to plan and manage ahead any potential problems that may arise, then professional tax advise for your own situation could help. Whilst there is no guarantee of a success with Buy-To-Let property investment, thorough planning and correct structure will help your chances of achieving it.
If you live in the Norwich area we would be happy to discuss Buy-To-Let property investment with you.
Please contact us for more detailed advice.