There are more medical professional clients who are looking to start property investment. It is important to be aware of the tax implications when you rent out a property and how different it is tax-wise when you rent it out. This is a guidance focusing on when you do not have to declare rental income in your tax return, buy-to-let tax changes and options to mitigate the tax impact.
Note – Please be aware that this article focuses only on tax legislations around properties. However, if you are looking for full property investment strategy, further specialist advice may be required.
Non-declarable Rental Income
If you are starting out or if you are a home owner and are renting out a spare room to earn extra cash, there are three types of scenarios where you do not have to declare your income such as:
- Rental Income Less Than £1,000 For the Year – If you are just starting out and only have £1,000 from the rental income for the year then you do not have to declare the income.
- Rent Out A spare-room for less than £7,500 for the year – If your earning collected for the year is less than £7,500, you do not have to declare it in your tax return.
- Property fund investment held in ISA – ISA is a tax-free environment, they are investments that you can choose from such as property funds. If you are earning income from an investment ISA then it is tax-free so you do not need to pay tax. It is important to speak to a financial adviser about ISA and investment.
In the past, there have been a few scenarios where there are people who rent out a property but do not fill in a self-assessment or declare the tax and eventually the tax man finds them. It is essential that you do fill in a tax return if you do rent out a property or for any other reason other than the three conditions mentioned in order to avoid being in the same situation.
Buy-to-Let Tax Change
From 17/18, if you have a buy-to-let property and are paying mortgage on it, the government starts to restrict the tax relief on the mortgage interest. Such mortgage interest relief will be cancelled completely by 2020-21. Mortgage interest can be the biggest expense currently for buy-to-let landlords. If the government do decide to cancel this tax relief it can be a significant impact.
An example of this is if you are a basic rate taxpayer, you earn around £25,000 and have a lease rental property which collects around £50,000 for the year. The mortgage interest would be £30,000 and other expenses are £10,000. This means that you will have £10,000 profit, in 17/18 you are able to claim 75% of it but until 2020/2021 the interest relief will be completely removed. The impact is that you will have up to 50% of what you have now. In this case, after tax and before the tax change, you will have £8,000 in your pocket. But in 2020/2021, you will only have £4,000. (Graph 1)
If you are a high rate taxpayer and earn £50,000, it will have an immediate impact on you. From this year you will have around £1,500 less but eventually in 2020/2021, the impact will be significant. (Graph 2)
Options to Mitigate the Impact
- Rental Loss Relief – If you have recently had a property loss, you can carry forward the loss to offset your profits. This approach is the cheapest and most straightforward strategy for you to mitigate your tax.
- Spouse Transfer – If you are married and the buy-to-let is under your name only, you might be able to consider having a shared ownership. This can apply to situations where if your spouse is not working or they are earning at a basic rate tax band. When you share the ownership, his/her share of that property profit will be reported by the lower tax bracket. This will help you to save tax.
- Re-invest in Commercial Properties or Furnished Holiday Lettings (Airbnb) – You can still claim the full mortgage interest relief if you invest in commercial properties or furnished holiday lettings. However, only take this approach if you are fully committed to do it and it is your own strategy. There are different mind-sets between having a property and collecting the rent compared to holiday lettings. This is due to constantly having to advertise your property and it is like a business, it involves a lot of work.
- Forming a Limited Company – Forming a limited company will protect you from the impact of the mortgage interest relief restriction. Corporation tax at the moment is only 19%, this is a huge tax advantage. You can also take further advantage if you have your spouse or family member become a shareholder of your company which will allow you to share the company income as well.
However, if you are running a very profitable property management business, the dividend tax is not as good as before which needs to be considered. When it comes to forming a company, when people consider transferring the assets into the company, if they do not do it considerably there is a capital gain tax implication. Another downside is if the properties are held in the company, the mortgage options are very limited. There are also more administration burdens such as; filing company accounts and company tax return. You may also need to run the payroll when you need to hire someone to manage the property business for you.