Synopsis: Summary of tax treatment of income and expenses on buy to let investments

Date posted: Thursday, June 04, 2015

So you are considering putting money into a buy to let property?

There are many factors to take into account in deciding if this will represent a suitable investment for you.

These will certainly include:

· Your available funds;

· Your existing investment exposure to residential property (including your own home)

· The necessity, availability, and attraction of borrowing to fund all or part of the investment

· The ‘hassle’ of being a landlord – with potential return comes responsibility

and, of course:

• The returns both in the form of rental yield (net of expenses) and realisable capital growth.

And then there’s taxation – a really important factor to keep in mind when assessing the likely net rental yield and net capital growth. But for landlords the reliefs available make tax a quite positive – even exciting – subject.

Let’s look at the all-important “money in/ money out” equation.

A recent survey of ‘Buy-to-let’ hotspots carried out by the Telegraph revealed gross rental yields of between 5.5% and 7.6%.

You need to factor in costs though to arrive at the net yield – and then consider taxation. And in arriving at the taxable yield whether or not an expense is tax deductible will be critically important.

Here is a summary of the key expenses a landlord will need to consider and whether they are tax deductible. We’ll then look at some simple examples.

Expense Tax deductible
Mortgage arrangement fees Yes
Mortgage interest (not any capital repayment) Yes
Letting agent fees (10-15% of the rent +VAT) Yes
Advertising for a tenant (say £300-£400 per new tenant) Yes
Maintenance and repairs (renovations but not enhancements) Yes
Wear and tear on furniture (round sum 10% of the rent

minus any costs paid on behalf of the tenant)

Ground rent and service Yes
Other direct costs of letting (eg phone calls, travel between properties) Yes

The general counsel of caution is to keep proof of all expenses in case required by HMRC.

So what does all of this mean in real money?

Well, say a flat in East London worth £500,000 yields a gross rent of £2,500 per month – £30,000 per annum. A Gross Yield of 6%.

If it were funded by an interest only mortgage of £300,000 then the net (and taxable) position could look like this

Rent (ignoring any voids – unlet periods) £30,000
Less mortgage interest

(@ 4.5% after an initial lower interest period)

Additional costs @ 15% of the rent (including insurance, maintenance) £ 4,500
Letting agents costs @ 10% (+ VAT) of the rent £ 3,600
Tax (assuming 40%) on £8,400 (£30,000 – £21,600) £ 3,360
Total net costs £24,960
Net received £ 5,040

The net yield pre-tax based on the gross purchase price will have fallen to 1.7%

(£8,400 on £500,000)

The net yield post tax will have fallen to 1.01%

If mortgage rates increased by say 1% to 5.5% this would add £3,000 to costs reducing the pre-tax yield to £5,400 (1.1%) and the post-tax yield to £3,240 (0.65%). Not much margin for error.

All of these yield figures, of course, are based on the full cost of the property, including the borrowed sum.

The tax deductibility of the key expenditures definitely helps to reduce tax costs and thus improved the net of tax yield.

In assessing the attractiveness of returns on buy to let property it is, of course, also important to consider the likelihood and extent of capital appreciation too. But here the impact of capital gains tax at 18% (for basic rate taxpayers) or, more likely 28% for higher rate taxpayers needs to be kept firmly in mind and the fact that gains are ‘lumpy’ as you cannot generally sell part of a property.

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