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Maximising tax savings for property landlords

In my experience landlords are particularly interested in capital taxes, so it is Capital Gains Tax that I will deal with first.

There is a £9600 annual exemption for CGT. So the questions to ask yourself are:

1 Are all members of the family making use of that exemption?

2 Are we making use of that exemption most effectively year on year?

For example, a client of mine recently sold a bungalow and paid about £30,000 CGT.

If he had asked me first, I would have sent him to his lawyer to deed a 50% share to his wife. She would get half his base cost and half his taxable gain but she has her own £9600 allowance and they would have paid £1728 less tax.

Most clients will choose to hold properties in joint names to maximise income tax allowances and lower rates, but if you do not want to do this, by following the above procedure there is £1728 tax to save.

Looking at this exemption another way, do not plan to sell all your properties in one tax year. If at all possible make one disposal a year and save two lots of £1728 each year. This is particularly important for a landlord who is winding down, perhaps for retirement.

There is no roll-over relief for selling and reinvesting in residential property for letting. Therefore now may be a particularly good time for clearing out a rogue property from your portfolio.

House prices and capital gains are down, CGT at 18% is a historically low rate and if you use two lots of annual allowances, you may avoid the tax altogether. Then you can reinvest in a higher yielding more reliable property.

The major relief for CGT is the PPR or Principle Private Residence relief. This is the relief that ensures you pay no tax when you sell your home.

But consider my client. Big house in Norfolk, buys a terraced house in Manchester for his student daughter, finds the yields in Manchester much better than those in Norfolk so buys a second house in Manchester and spends four months living in the property while he does it up. By nominating the Manchester property as his Principle Private Residence for the four months that he lives there he guarantees a minimum of three years PPR relief from capital gains tax for the Manchester property. If he subsequently lets the property he can claim letting relief in addition (it is only ever an addition to PPR) which potentially doubles the amount of relief to six years, but letting relief is capped at £40,000.

He is thinking of doing another project in Manchester and I am surmising that he might secure 12 years exemption from CGT spread over two properties in one 12-month period.

I must stress it is critical to nominate back to your main home when your residence in the investment property ceases!

In contrast consider my clients with an executive bungalow in Newmarket. Very upset with a £30,000 CGT liability on an investment property in the same town.

I calculated that if they moved into the investment property for a few months before selling it they might save almost all of that gain. In fact the wife eventually decided that the tax would have to be paid. But for some of you moving into a rental property for a few months might be a perfectly acceptable way of avoiding £30,000 of tax. Consider this when you are choosing what property to buy!

Moving now to income taxes but staying with the theme of choosing the right property I would like to remind you of another little allowance of £4250 tax free income per year. If you are a 40% taxpayer this is quite valuable, at £1700 per year!

This is the "Rent-a-Room Scheme", which is applicable if you rent a room in your own home. Most landlords will not want to do this. But consider one of those four-storey terraced houses, with steps up to the front door. The basement is an integral part of the house. If converted to a flat separated only by a lock on an internal door, it qualifies for Rent-a-Room relief.  The tax-free rent may be a very welcome contribution to the economics of buying this type of home. The same consideration may apply to a more rural property with a room or rooms that can be effectively self-contained although primarily designed as part of the main home.

The same mindset that applies for capital gains tax applies for income tax. You should ask yourself "are you using the personal allowance available to all members of your family?"

In particular you may well want to bring in teenage or student children as joint owners of one (or more) investment properties (perhaps the student’s home while at University.)  They will have up to £6035 of personal allowance available in the current year. And it is better that they have some of "your" rental income to spend on clothes and entertainment than that they have a similar amount of your taxed income.

Costs and expenses are a very interesting area for landlords.

First, let me be clear, there are no reliefs against income for expenditure on purchase or improvement of the property. Thus it can be very important to distinguish improvements from maintenance. The legislation has some very onerous rules. For example, if any item of expenditure includes an element of improvement it is all treated as improvement. If you replace a worn-out kitchen with a modern equivalent, then the new kitchen is a replacement and the expense can be claimed, alongside other maintenance expenditure, against rental income.  If however you succumb to the temptation to be a good landlord and put a better kitchen in perhaps for £2000 instead of an £1800 replacement then the whole of the £2000 expenditure is treated as improvement. There is no claim for the £1800 element of replacement.

As well as this onerous rule there is a second problem. If you buy a property for £160,000 and spend £40,000 on it before letting it, HMRC’s view will be that the cost of bringing that property into a state where it can be let, is £200,000 not £160,000. There will be no allowance for maintenance even if the bulk of the cost is for decoration and replacement of a tired kitchen, bathroom and windows.

What can you do about this?

1 Try to buy a property that you can let before you do extensive maintenance on it, and let it first;

2 If you are doing any improvements, putting a new room into the loft for example, do not mix this with any maintenance or replacement expenditure;

3 Make sure your suppliers provide documentation which distinguishes between capital (improvement) and revenue (replacement) expenditure;

4 Last, you should have been doing full (proper) accounts for your rental business for the past few years. If you have not been, you should be. There is a major advantage with doing a proper balance sheet in that you record capital expenditure in the accounts each year. You thus have the full cost of all improvements over 10 or 20 years recorded when you come to sell the property. This will potentially save substantial Capital Gains Tax and will often pay for all the accountancy fees.

If you do not have such accounts, very few people will be able to find or prove all the improvement costs that are allowable against the capital gain.

The other main cost that causes confusion is interest.

Until 2005 only interest on loans to purchase or improve property or to refinance earlier loans could be claimed. Since 2005 the same rules that apply to a trading business apply to landlords.

The first most common question is: Can I claim the interest on a mortgage taken out against my own home if I have used it to pay the deposit on a Buy-to-Let? The answer is an unequivocal yes! It was always so even under the pre 2005 rules. However, if you have documentation saying that the loan was to build a conservatory on your own home because that is what you told the lender, HMRC would have taken this as evidence that the loan was not for commercial reasons (after all, it is a criminal offence to obtain a loan by deception). Under the current regime according to its website HMRC would take the view that the loan was not for business purpose and that therefore the interest is not allowable. That is not my view or most of the profession.

We consider that as long as borrowing does not exceed the cost of assets (broadly property and improvements) then any interest suffered on loans is allowable. However, again it is very important that proper accounting records, including a balance sheet are maintained.

I certainly have buy-to-let landlords who have bought properties for £80,000 obtained valuations at £100,000 and borrowed £120,000. They tend to be very disappointed when they find that only two-thirds of the interest that they are paying is allowable against tax.

Phil Needham is Director of Hornbeam Accountancy Services

For more information phone: 01603 720424 or email phil@hornbeam-accountancy.co.uk 

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