Tax Planning for Property Investors – Your Questions Answered
First Published: May 2010 | Available in: Property Articles Your Property NetworkIt’s that time of year when we all need to start thinking about submitting our tax returns and so with this in mind YPN have asked property tax expert Stephen Fay to answer some of the questions he most frequently gets asked by property people.
Stephen combines expert technical tax knowledge with real-life property investment experience to offer property investor clients a unique service. Here, Stephen answers some recent questions posed by investors …
I am told by my accountant that I can’t run my rental properties as a business as it is deemed as passive income – is this correct?
Property investors usually own their rental properties in their personal name (or jointly). For tax purposes, rental profits are taxed as ‘investment income’, rather than as ‘self-employment income’. This is good news, as investment income is not subject to National Insurance – a tax saving of 11% compared to employment income!
For income tax purposes, a ‘property rental business’ (as HMRC calls it) is a ‘business’. Therefore, just like any other business, direct costs and all sorts of general expenses are deducted from business profits to arrive at the taxable profit. The expenditure must be ‘wholly and exclusively’ for business purposes though, just like any other business (those ‘tenant entertaining’ tickets to the football don’t count!).
Ensuring that all possible costs and expenses are picked up, especially over several years, really does make a difference to income tax bills, so it’s important that investors are diligent with their record-keeping … most large businesses devote a lot of effort to simple good housekeeping … so should property investors. For example, if you pay out £5k in cash to tradesmen without any records, is it really worth losing that amount as a tax deduction? For a 40% taxpayer, that can mean £2k extra income tax.
What’s the deal with refurbishment projects? If I spend thousands of pounds on a refurb on a new property purchase can I claim these funds against income tax or just capital gains?
The capital vs. revenue expense question is one of the most commonly asked questions from investors!Briefly, property repairs and general maintenance are classed as ‘revenue’ expenses (and so deducted from rental profits) if these only restore the property to its previous condition, and don’t ‘enhance’ the property value.
Practically, most general ongoing refurbishment work will be allowable against rental profits. Generally, capital items include extensions, structural changes, and significant ‘improvements’ over and above a simple repair or replacement. One common scenario is where a refurbishment is completed prior to letting. Most BTL investors will have had a survey performed, which will specifically state that the property is of a lettable standard at purchase. This, along with invoices and photo evidence, can be used to support a case for treating those initial refurbishment costs as revenue costs. In most cases it is a simple matter of common sense judgement.
When completing refurbishment work that is a mixture of revenue and capital spending, the works should be sensibly allocated between revenue and capital (it is worth asking the builder to invoice specific repairs and maintenance items (revenue) separately to capital improvements).
One final tip – make sure you keep all those capital spend receipts! Over the years, these can add up, and along with the purchase and sale costs, will help to reduce the capital gains tax due on sale (which is very likely to be at a higher rate than the current 18%!).
Also what about professional fees such as architects? In a similar vein what about the cost of the valuation that I get charged and also the product fees that mortgage lenders charge?
Architect fees usually relate to capital expenditure.
All interest and fees associated with financing a property purchase, or its refurbishment, or funding working capital, are allowable against rental profits. This includes the valuation fee (IF it was the minimum required to obtain the finance – anything above the minimum is a capital cost), application fee, product fee (whether added to the loan or not), TT fee, mortgage broker fee etc.
Any costs that are specifically to do with acquiring, rather than financing, the property are capital costs and tax relief is available when the property is sold.
Bit of a cheeky one – can I claim the cost of paying my accountant against my rental income?
Absolutely – every business has accountancy and tax advice costs, which are normal business expenses. Strictly, the cost relating to the ‘personal element’ of the SA100 Self-Assessment Tax Return (i.e. everything other than the red Land and Property Supplement) is not a business expense (it relates to the investor’s personal affairs), although, by HMRC concession, the full cost is allowed as an expense. Some investors with very complex affairs (or expensive accountants!) may need to separate this element out.
If I move one or more mortgages to a repayment basis, what would the tax implications be?
Very simply, only the interest paid is an income tax deduction. Therefore, for tax purposes, it doesn’t make any difference if you have a repayment mortgage or an interest-only mortgage – only the interest element is allowed for tax purposes.
For example, both Bill and Bob each have a £100k BTL fixed-rate mortgage, charged at 6% interest. Bill pays £500 per month on an interest-only basis, whereas Bob pays £585 on a repayment basis. In BOTH cases, the interest element of £500 per month is an allowable expense. The additional £85 per month paid by Bob is NOT allowed, as he is simply lowering his debt (the£85 is not a cost).
As Bob’s balance reduces, so too does his interest bill. Let’s say Bob has repaid £1k after a year, and so then owes only £99k. Although both investors continue to pay the same, Bob’s tax deduction drops from £500 to £495, as he has repaid a little capital and so less of his fixed payment is interest. Bill stills pays £500 interest, and gets £500 interest deduction.
Which is best? It depends on your circumstances, your finances, your expansion plans and your attitude to risk. Bob is actually making more profits that Bill, as his interest payable is less. Don’t forget that profits, in business, are a good thing! Investors should focus on making profits, and have their accountant focus on reducing the tax liability. Few successful businesses take the view that running high expenses just to obtain a tax deduction is a good thing!
Having said that, most investors would rather invest their surplus funds in more property rather than reducing debt … its ‘horses for courses’ really.
Are there any other costs that I can be claiming against my portfolio that most of us would not think about?
Yes – lots! As well as the ‘big ticket’ costs like mortgage interest, letting fees, insurance etc, investors can also claim for ‘administrative expenses’ such as travel, phone and office costs, training, use of your home as a business office etc. Working with an accountant who has an in-depth knowledge of what can be claimed is essential, especially now that the new, more draconian, HMRC penalty regime is in place. It’s worth just mentioning a couple of points that are often overlooked. A ‘provision’ for a future expense that has not yet been paid, but is due, is allowable for income tax purposes. The legal obligation must have been incurred, and the amount must be calculated with reasonable accuracy (e.g. a leaseholder is notified of a new roof requirement before the ax year ends, with payment actually due after the tax year end).
Also, ‘pre-commencement expenses’ (incurred before a property rental business commences) may still be claimed as allowable business expenses if they would normally qualify as such. Such expenses can be claimed for up to seven years before the business commenced, and are treated as being incurred on ‘day 1’ of the property rental business commencing.