Lots of people have a buy-to-let property as a pension, often because they like the certainty of bricks and mortar as opposed to the fluctuating stock market.
But the landscape has changed in recent months due to the cost-of-living crisis, with many people wondering whether they should continue to hold onto their property.
Here, head of taxation, Andrew Diver explains how the latest changes increase the cost of renting out a property and offers some points to consider.
Firstly, interest rates have increased with fixed deals on buy-to-let properties now around 5% whereas, twelve months ago the rates were closer to 2.5%. So, buy-to-let owners with significant mortgages, will see their returns decreased.
Fiscal drag also plays a big part in the highs and lows of owning property to let. Fiscal drag is the inflationary effect of the tax system on the economy.
The UK has increased its tax thresholds below the rate of wage inflation for many years now, which means more people pay higher rates of tax.
It is estimated that during this parliament, there will be 2.5 million more higher rate taxpayers.
The increase in interest rates will be more significant because mortgage interest relief is restricted to 20%. In the worst case scenario, with high levels of loan to value (LTV) a taxpayer might make a loss from letting a property (after deducting interest costs) but will still be liable to additional tax on the tax adjusted profits.
The other element of fiscal drag, which is relevant here, is in relation to inheritance tax.
The amount you can pass to your family (except spouse) has been frozen at £325,000 since 2008/09 and house prices have continued to increase to the point that many more people are being liable to inheritance tax where the majority of their estate is property investment and they may wish to take steps to lessen the impact of this.
In 2008/09 the average house price was £157,200 which was 48.36% of the inheritance tax nil rate band. Now the average house price is £297,524 which is 91.54 of the inheritance tax nil rate band.
One option is to sell the property. Whether or not it is a good time to sell is not for us as accountants to say. But if that is what you choose you should firstly check you will not incur substantial tax liabilities. If a property has not been your main or only residence throughout the entire period of ownership, then any increase in the value of the property will potentially be liable to capital gains tax.
There are several exemptions that can be claimed, which could reduce the taxes due. Particular attention should be taken where a property has been occupied as a main residence and might be reoccupied before selling, as numerous exemptions relate to periods where there have been gaps in occupation.
The capital gains on the sale of UK residential properties must be reported to HMRC within 60 days of the completion of the sale. Tax should also be paid at this time. Penalties apply if returns are not submitted within this time limit.
Ownership through a company
An alternative is to consider undertaking residential property investment through a Limited Company or Limited Liability Partnership which can obtain full deduction rates for mortgage interest and be subject to lower tax rates.
If structured correctly these arrangements can enable taxpayers to continue to benefit from the rental income of the property, whilst the value of the residential property sits outside of their estate for inheritance tax purposes.
If there is a large capital gain on a buy-to-let property and you want to consider passing it down a generation, it can be worth using a trust, as it is possible to transfer property into a discretionary trust without triggering capital gains tax.
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