How to Reduce Tax on Rental Income

Nikka Sulton

How to Reduce Tax on Rental Income

When selling a buy-to-let property, you can’t completely avoid capital gains tax (CGT). However, there are ways to reduce it. You can use your tax-free allowance, consider joint ownership with a spouse, and deduct relevant costs. Additionally, setting up as a limited company and checking if you qualify for private residence relief can help. Understanding CGT rules for BTL properties is crucial to minimize your tax bill.

Due to the complexity of these rules and the potential impact on tax bands, professional tax planning advice is advisable for those looking to lessen the CGT burden when selling BTL property. CGТ rules can become intricate, especially for basic-rate income taxpayers, as the sale may push them into a higher tax band. Therefore, seeking guidance from tax professionals can help you navigate this process and optimize your tax liability.

Why do you pay capital gains tax on buy-to-let property?

When selling a buy-to-let (BTL) property, the owner is subject to capital gains tax (CGT) on the profit from the sale. This applies similarly to other valuable assets like jewelry, artwork, and shares when they result in a profit. Typically, CGT is not levied on the sale of a person’s primary residence due to private residence relief.

Reporting and paying CGT for BTL properties changed in April 2020, with a further amendment on 27 October 2021, extending the deadline from 30 to 60 days. This means that sellers must calculate, notify, and pay the CGT owed to HMRC within 60 days of completing the property sale, a relatively short timeframe. Failure to notify HMRC within the same tax year can result in interest and penalties.

For instance, selling a rental property in March 2020 allowed the CGT to be reported on the 2020/21 tax return, offering more time. However, if the property was sold on 28 October 2021, the necessary paperwork and payment to HMRC should have been completed by 27 December 2021. This change reduced the time available to fulfill CGT obligations, compared to the initial legislation of April 2020, which only provided 30 days.

How is CGT calculated on buy-to-let property?

Most buy-to-let (BTL) properties are subject to capital gains tax (CGT) upon sale. The CGT rate stands at 28% for higher-rate taxpayers and 18% for basic-rate taxpayers, applicable to any profit gained from the property’s increased value since purchase.

Basic-rate taxpayers should carefully consider their financial situation or consult with a tax planning professional, like an accountant, before selling a BTL property. The profit from the sale is added to your income, potentially pushing you into a higher-rate tax band.

Each taxpayer benefits from a tax-free capital gains allowance of £12,300 (2022–23). Consequently, CGT is only imposed on gains exceeding this threshold.

Additionally, there are allowable costs that BTL property owners/sellers can deduct, including stamp duty from the original purchase, solicitor fees for selling the property, estate agent fees for selling, and expenses related to capital improvements like extensions, energy efficiency enhancements, or a new kitchen.

However, expenses like property upkeep and mortgage interest payments cannot be offset against CGT.

Do I pay capital gains if I reinvest the proceeds from sale?

Even if you reinvest the proceeds from selling your buy-to-let (BTL) property into another property, you are still liable for Capital Gains Tax (CGT). However, CGT is not calculated on the entire sale proceeds. You subtract the property’s purchase price from ten years ago and can offset expenses like solicitor’s and estate agent’s fees, as well as stamp duty.

Alternatively, if you want to continue investing in property while simplifying tax matters, you can consider putting your money into a Real Estate Investment Trust (REIT). REITs are property investment companies designed to replicate direct property investment in the UK.

Operating through an REIT offers benefits such as not paying corporation tax on rental income or gains from property sales. Additionally, investing in REIT shares can be done within an ISA, potentially making them tax-exempt, subject to ISA limits. This approach can help you navigate CGT and corporation tax issues while avoiding additional layers of taxation associated with investing through a corporate structure.

7 Tax Saving Strategies For Landlords

To be a successful buy-to-let landlord, you must consider tax efficiency, a factor often overlooked but crucial for savings. Here are two practical tax-saving strategies for landlords:

1. Set up a limited company

While it requires planning, forming a limited company can significantly reduce your tax burden as a landlord. This approach allows you to purchase properties through the company, enabling cost offset against profits. Additionally, you can employ yourself or others to manage properties in your portfolio. Though not suitable for everyone, this strategy can lead to substantial savings, so consult your accountant to explore the potential benefits.

2. Extend to increase returns

Investing in improvements for your existing properties can help avoid hefty stamp duty charges and increase your portfolio’s value. Recent changes in development rights permit larger property extensions, potentially boosting monthly income. However, consider the area’s price ceiling where your rental is located to ensure profitability. Be aware that significant improvements may trigger the need for an HMO (House in Multiple Occupation) license if your property houses five or more tenants. Check your local council’s licensing rules before undertaking costly renovations that may change your property’s status.

3. Leverage all available tax bands

Consider transferring your assets to your spouse as a means to potentially reduce your tax liability. Capital Gains Tax is typically not applicable when assets are transferred between spouses. This approach allows you to take advantage of their lower tax bands. If their tax bracket is lower than yours, you might also pay less tax on rental income. If the property lacks a mortgage and you don’t gain financially from the transfer, you won’t incur stamp duty either.

4. Optimize property value

Reassess your rental property’s value regularly. This often-overlooked step can have a significant impact on your business. An accurate property assessment not only determines its actual worth but also enhances your position with lenders. If your property’s value increases, your loan-to-value ratio improves, potentially offering more options and better interest rates for your buy-to-let business. If you’re in East London or West Essex, consider consulting valuers to get started.

5. Claim all allowable expenses

Ensure you claim all eligible expenses to become a tax-efficient landlord. While being diligent about expenses, keep records of receipts and consult with your tax advisor or accountant to understand what you can and cannot claim. Many landlords could reduce their tax bills by simply being more diligent about tracking expenses. Expenses such as home office costs and letting agent fees can be offset against profits, so take full advantage of these deductions.

6. Consider short-term lets

During tenant transitions or void periods, you can reduce your landlord tax bill by claiming expenses like council tax and utilities. However, instead of solely saving money during these periods, you might want to explore short-term lets to generate income. It’s worth considering this option to keep cash flowing even when your property is vacant. If you’re in East London or West Essex, our lettings team can assist you; give them a call at 020 8989 2091.

7.Be tax-savvy when selling

Many landlords miss out on potential tax savings when selling rental properties because they don’t fully utilize available tax relief. This is especially relevant for landlords with multiple properties who can take advantage of the 0% Capital Gains Tax band when selling one of their homes each year. Currently, the tax-free threshold is £11,300, offering significant savings. To maximize tax savings, consider working with a skilled accountant and a trusted tax advisor who can guide you through the process. This article provides insights into ways to lower tax bills but should not be taken as specific advice.

Claiming All Expenses

You can’t avoid paying tax on your rental income, but you can reduce your tax bill by claiming certain allowable expenses associated with property management. These expenses are the day-to-day costs of running your rental property, including:

Landlord insurance for buildings, contents, and public liability.
Fees paid to letting agents and property managers.
Ground rent and service charges.
Cleaning and gardening costs that you cover.
Fees for accountants.
Expenses related to advertising for tenants.
Stationery and phone calls directly related to your property business.

To determine a reasonable rent for tax purposes, calculate your monthly expenses for the claimable items and divide that amount by the percentage of your property used for business, typically one room. For instance, if your property has seven rooms and one is used as an office, the rent is based on one-seventh of the eligible expenses. If your office is open for an average of seven hours a day, you would calculate 7/24th of the total and include it as rent in the agreement. This approach helps you accurately account for allowable expenses when reporting your rental income for tax purposes.