Buy-to-let properties, when managed correctly, can be a great investment and good source of income. They do bring with them several financial considerations however, and have significant tax implications, making it very important to plan carefully when considering a purchase. Whilst the potential returns on investment may be high, a poorly planned buy-to-let purchase can easily see you losing multiple thousands of pounds.
‘Buy-to-let’ is the term given to any property bought with the intention of being rented out to tenants, rather than the purchaser living there themselves. Despite attempts by the Government in recent years to curb enthusiasm for the sector, purchasing property remains a popular form of investment, with buy-to-let properties accounting for roughly one in ten property purchases in the country.* (* The Financial Times, Feb 27th 2019 )
Buy-to-let properties, when managed correctly, can be a great investment and good source of income. They do bring with them several financial considerations however, and have significant tax implications, making it very important to plan carefully when considering a purchase. Whilst the potential returns on investment may be high, a poorly planned buy-to-let purchase can easily see you losing multiple thousands of pounds.
Buy-to-let Mortgages
Unless you are in a position to purchase the property outright in cash, most people finance their purchase using a buy-to-let mortgage through a mortgage lender. Unlike the ‘standard’ type of mortgage used when purchasing your own home, eligibility for a buy-to-let mortgage is not solely based on personal financial circumstances such as income and credit history. Whilst these factors do still play a role, the mortgage will largely be based on the rental income you expect to earn from the property itself. Lenders will usually require you to earn at least 25% more each month in rental income than you will be paying in mortgage payments, whilst also requiring a larger deposit up-front (typically 25% of the purchase price) in order to safeguard their investment.
When planning for your mortgage, it is important to keep in mind that there will most likely be periods where no tenants are living in the property, and you will not be making any rental income. The mortgage will still require paying each month however, making it very important to plan ahead for keeping up with the re-payments. You will also need to account for insurance, maintenance costs, repair works, the cost of letting agents and any other unexpected costs that may arise, such as a broken boiler. When planning your finances in anticipation of a buy-to-let property purchase it is essential that you build a financial ‘buffer’ in to your plans in order to take every potential cost into account.
In April 2016, the Government introduced a higher rate of Stamp Duty Tax, payable on any buy-to-let or ‘second’ property. Under this new legislation, you will be required to pay an additional 3% of the purchase price, on top of the standard rates of Stamp Duty Tax that are already payable. Stamp Duty Tax is payable in bands and will be calculated based on the purchase price of the property, with the rates being as follows:
|
Tax Band |
Normal Rate |
Higher Rate |
|
< £125k |
0% |
3% |
|
£125k - £250k |
2% |
5% |
|
£250k - £925k |
5% |
8% |
|
£925k - £1.5m |
10% |
13% |
|
> £1.5m |
12% |
15% |
So, for example, on a buy-to-let property purchased for £260,000, you would be required to pay £10,800 in stamp duty tax. This would be 3% of the amount up to £125k, 5% of the amount between £125k and £250k, and then 8% of the remaining £10,000, broken down as follows:
|
£260,000 Purchase Price |
|||
|
Tax Band |
Higher Rate of Tax |
Taxable Amount |
Tax Payable |
|
< £125k |
3% |
£125,000 |
£3,750 |
|
£125k - £250k |
5% |
£125,000 |
£6,250 |
|
£250k - £925k |
8% |
£10,000 |
£800 |
|
£10,800 Total Payable Stamp Duty Tax |
|||
The income you make from rent is also subject to Income Tax. Until recently, if you rented a property you were eligible for a large amount of tax relief, where you could offset mortgage payments against rental income. You were able to subtract the total amount of money spent in mortgage payments from the total amount you had taken in rent, and thereby significantly reduce the overall figure that the income tax was calculated against.
New legislation was created in 2017 however, introducing new, different rules on Income Tax. These new rules have been phased in gradually each year since then, but are now fully implemented for April 2020 and the upcoming tax year.
Going forward, you will no longer be able to deduct mortgage repayments directly from rental income when calculating tax. Instead, you are entitled to tax relief of 20% of your total mortgage payments, which is then deducted from your payable tax. The tax figure it will be subtracted from however, will now be now be calculated from your entire rental income. Whilst the exact amount of tax payable will depend on the tax bracket you fall into (and with your income no longer being offset by mortgage payments, you may well find yourself being pushed into a higher tax bracket) those in higher tax brackets stand to pay a larger amount of income tax. As a rough example based on the 40% tax bracket, the income tax payable could break down as follows:
You earn £10,000 a year in rent, and pay £9,000 in mortgage payments.
Under the old system:
£10,000 Rental Income
- £9,000 Mortgage Payments
= £1,000 taxable income.
40% of £1,000
= £400 total payable Income Tax
Under the new system as of April 2020:
£10,000 Rental Income
40% Tax Bill = £4,000
Tax Relief on Mortgage Payments (20% of £9,000)
- £1,800
= £2,200 total payable Income Tax
As you can see, the tax implications under the new system could see landlords paying a much larger amount of tax than before. This is only a rough example however, and it is important to keep in mind that income tax will be highly variable depending your own financial circumstances. We would always recommend that you seek the appropriate financial advice from a financial adviser to discuss the potential tax implications before deciding to purchase a buy-to-let property.
Buying a rental property brings several legal aspects to take into consideration.
In order to purchase the property itself you will need to instruct a specialist to carry out the conveyancing legal work. The process of buying a buy-to-let is much the same as purchasing any other property, and will require all the same title checks, searches, enquiries and associated legal work. Our Residential Property team would be more than happy to assist you with your purchase, and you can read more about our conveyancing process here: https://www.bannerjones.co.uk/for-you-your-family/services/residential-property/buying
Once you own the property, as a landlord you will also need to have tenancy agreements drawn up between yourself and your tenants. These are contracts outlining the terms and conditions of the tenancy, as well as the rights and responsibilities of yourself and the tenants. It is important to have a tenancy agreement prepared by a professional, in order to fully protect yourself and ensure everything complies with Government regulations. Our Business Legal Services team are highly experienced in preparing tenancy agreements that ensure you are properly protected and would be glad to help draw these up for you.
Going forward, there may also come a time where you are unfortunately faced with problematic tenants. There may be issues such unpaid rent, damage to the property, or breaches of the tenancy agreement. These can be very difficult situations to navigate, and our Dispute Resolution team have a great deal of experience in helping landlords find practical, effective solutions to these kinds of problems. To read more about how the team can help, please follow the following link: https://www.bannerjones.co.uk/for-you-your-family/services/dispute-resolution/landlord-and-tenant-disputes
Owning investment property also brings several other potential factors to take into consideration. You may find it beneficial to form a company through which to purchase buy-to-let property, rather than doing so in your sole name, particularly if you own several properties. You should also remember that these properties will form a significant part of your financial estate, and will need to be protected properly through an appropriate Will.
If you have any queries at all about purchasing a buy-to-let – whether it’s your first property or you own a large portfolio, please do not hesitate to contact our offices. Our award winning teams are highly experienced in dealing with all aspects of buy-to-let property, and would be more than happy to help guide you through any element.
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