Investing in property to let
William Mackenzie provides an outline of the most important tax and commercial factors to be taken into account by dentists when deciding whether or not to invest in property to let.
Record numbers of individuals - including dentists and other professionals - are putting their money into property in the form of buy to let investments. According to statistics recently released by the Council of Mortgage Lenders, banks and building societies lent a total of £7.7bn to landlords in the first six months of this year - a 40% year on year increase. Dentists need to be aware of the commercial factors driving this surge in investment and also the tax considerations to be borne in mind if they are considering investing in this sector.
COMMERCIAL CONSIDERATIONS
With interest rates at a 50 year low and a poor stock market performance in recent years, property is seen as a relatively save haven. Investing in residential property is viewed as a means by which:
- Relatively secure capital gains can be achieved on eventual sale
- Steady income returns can be achieved throughout the period of ownership
- Mortgage finance is covered in repayment terms by the security of the eventual sale of the property and in interest terms by the rental income
Many dentists view an investment in the buy to let market as a useful supplement to the NHS Pension Scheme and other traditional pension plans.
PROCEED WITH CAUTION
Short term considerations
Due to the significant investment in buy to lets and low interest rates, gross rental yields are at historically low levels. With interest rates widely expected to rise soon and the major banks beginning to tighten their buy to let lending criteria the short term looks decidedly rocky. However, taking a long-term view, demand for rented property is expected to grow substantially - mainly on account of demographic factors.
Other key factors to be taken into account
The trouble with national statistics is that they are averages across the whole of the country and they mask significant regional variations. By all accounts the North is presently far more buoyant than the South and yields are higher on account of the fact that property prices are more realistic. University towns are always more popular on account of student demand which underpins the market. Two bedroom flats are in greatest demand as they appeal to the greatest number of prospective tenants.
TAX CONSIDERATIONS
The major taxes impacting on property consist of income tax, corporation tax - where investing through a company and capital gains tax (CGT). Inheritance tax (IHT) and stamp duty are also important but are beyond the scope of this article. An initial decision has to be made as to whether the property is going to be owned by:
- An individual
- A partnership or joint ownership - usually but not necessarily, a spouse
- A limited company
There are significant differences in the tax treatment of property owned by an individual or partnership on the one hand and a limited company on the other. This will be dependent on a number of factors.
Investing through a limited company
One of the most frequent questions I am asked in practice is whether buy-to-let property should be bought through a company or not? It is easy to see why clients ask this question. After all, the first £10,000 of profits in a company are taxed at 0% and the small companies corporation tax rate is only 19% as opposed to the higher rate of income tax of 40%. The trouble is that things are not quite what they seem! As long as the profits are retained in the company there is no problem. The problems start when extracting profits from the company. Should the owner/s draw money out of the company - either in the form of salary or dividend then further income tax is payable. Also, each time a property is sold corporation tax will be payable - assuming that the sales proceeds are not re-invested.
Tax deductions - individuals and companies
Similar rules apply for income tax and corporation tax. Rental income is usually taxed as investment income. This does not have too much affect for income tax purposes but it does have a marked affect for CGT purposes, which is referred to below.
Allowable expenses include mortgage interest, insurance, management expenses (including advertising for tenants), repairs and redecoration. Improvement expenditure on such items as building extensions, installation of central heating and major works are not allowable as a deduction for income tax purposes although they are deductible in calculating any capital gain. In addition, wear and tear tax allowances of 10% of rental income can be claimed to cover the cost of normal renewals of furniture and equipment, where furnished accommodation is let.
Capital gains tax
As if tax is not complicated enough, there are two different systems for calculating CGT - one for individuals and a different system for companies. In this article I only refer to the system insofar as it affects individuals.
Investment property does not qualify for business asset taper relief. Taper relief reduces gains on a sliding scale according to the number of years that the asset has been held and a higher rate of taper relief applies to business assets than to non-business assets. As most dentists will be higher rate taxpayers, the effective minimum rate of tax that will be paid on disposal and assuming maximum reliefs will be 24% as opposed to a minimum of 10% for business assets.
William MacKenzie is a chartered accountant specialising in the tax affairs of dentists. Contact him on 01483 419922, email wtm@accmac.plus.com or visit his website at www.wesaveutax.co.uk
