Financial Planning and tax advice for landlords

In association with Chiene + Tait Financial Planning.

Renting your property

Whether you already own an investment property, have recently inherited or acquired a property, or you are looking to move out of your current home, it is important to know what your options are.

To sell or to rent? This is a significant decision that many fortunate individuals will face throughout their life. The outcome of this decision must be based on your personal circumstances and financial plans.

Having a rental portfolio can be a great source of additional regular income. Typically, this surplus income is enough to cover any monthly costs relating to the property i.e. mortgage and factors fees, and in some cases, you may be left with extra cash, all while gaining equity on the property.

Holding onto a property which has great rental value can be a fantastic investment however, it completely depends on your personal circumstances.

What to think about when making the decision to rent or sell

It is critical to take expert financial advice to understand how the advantages and considerations relate to your personal circumstances. However, noted below is a list of general advantages and considerations:

Advantages

• Rental income – renting out your property can provide you with a steady source of reliable income. When managed correctly, this income can also be inflation proofed to ensure you are never losing value in real terms.

• Capital growth – even though you are renting the property, you own the asset (flat, house, unit), meaning you will solely benefit from any increase in capital value. Average property prices across the UK have risen by 53% over the last decade – this capital uplift along with a monthly rental income is extremely attractive for any investor.

• Property allowance – the first £1,000 of property income per individual is tax free therefore, if you jointly own a rental property, the first £2,000 of income would be tax free.

• Personal allowance – if you do not currently utilise your full personal allowance (amount of income you do not need to pay tax on) of £12,570, any rental income can be offset against the unused amount therefore, generating more tax-free income.

• Allowable expenses – just like a business, a landlord is able to reduce the amount of tax they pay on property income by deducting allowable expenses. Allowable expenses are things such as letting agents’ fees, cost of maintenance and repairs, bills (utility, gas, water etc).

• Letting agent – you can outsource landlord responsibilities to a letting agent to free up your time. This can be particularly useful if you are working and do not have the time to manage your rental property.

Considerations

• Affordability – can you afford to rent the property? There are various costs involved in renting out your property and therefore, it is important you consider these costs before deciding.

• Additional Dwelling Supplement (ADS) – if you are buying a second property, you will have to pay an additional 4% on the property price as extra Lands and Buildings Transaction Tax.

• Emergency fund – can you afford to set aside an emergency fund? Tenants can cause damage to your home, things may break, all of which may not be covered by your insurance.

• Liquidity – if you require capital from your investment then an illiquid asset like a house, flat, unit etc is not the best approach for you.

• Income tax – before renting your property, you will need to consider any additional tax commitments you will have as a landlord. Any rental income you receive will be added to you existing income, therefore this income may push you into a higher rate tax bracket.

• Capital Gains Tax (CGT) – you may be under the impression that growth in the capital value of your property is tax free. This is the case with your main residence, however, this does not apply to your second property. Therefore, any capital growth is subject to tax at the time of sale.

How you can protect your wealth from the tax man

If you have invested in buy-to-let, it is likely you have done so with the following objectives:

• creating a steady personal income;
• to secure a future for your family.

Unfortunately, wealth that is tied up in property often comes a significant Inheritance Tax (IHT) burden.

HMRC deem you to have an ‘investment business’ if you are renting out properties with the purpose of generating income. As a buy-to-let is classified as an ‘investment’ business and not a ‘trading business’ they do not receive any IHT tax relief. To compare, ‘trading’ businesses are usually up to 100% exempt from IHT because of Business Property Relief (BPR).

What does this mean for you? This means that, building a large buy-to-let portfolio will generate significant capital which is extremely difficult to pass down without creating a substantial IHT bill.

Please note, this IHT bill must be paid within six months of your death and must be paid before your inheritors can sell any of the properties. This raises another important question – how are they supposed to raise the cash to pay the tax?

If you get started as soon as possible, there is a lot you can do to reduce the IHT burden to a manageable level, and perhaps eliminate it all together.

It is critical to take expert financial advice to understand and create a plan which is tailored to your personal circumstances. However, I have noted some of the basic strategies below:

• Gifting – this is the simplest and most effective way of reducing the value of your taxable estate. Simply sign over some, or all of your properties to your children for example, and as long as you survive seven years post gift, there will be no IHT to pay on those properties.

• Create a trust – even if you can afford to give your property away, you may feel uncomfortable about gifting. If the beneficiary of the gift is too young, or less responsible than you’d like, a gift may not be a good idea.

You could instead set up a trust to hold the properties on their behalf. Provided you don’t include yourself as a beneficiary of the trust, there will be no IHT to pay after seven years.

You can only put a maximum of £325,000 into this kind of trust, or £650,000 if you’re a couple. However, if you stick to those limits, you can do it again in seven years’ time without incurring a tax liability.

• Use your Pension Lifetime Allowance (LTA) – pensions do not form part of your estate for IHT purposes and are therefore free of IHT.

The LTA is currently £1,073,100 for the 2022/23 tax year. So, if you are a couple, you have roughly £2 million between you. If you have some LTA left, then it may be beneficial to transfer the properties into your pension fund and shield them from IHT.

It is important to note that this can only be done for commercial property (offices, retail space, factory etc), and not residential property.

• Use Life Insurance – you can take out a life insurance policy to cover your IHT liability. You would need to work out the value of your property portfolio, and the amount of tax due. Your policy would then cover you for the full tax liability.

You must make sure your policy is ‘written in trust’ to ensure the policy proceeds do not form part of your taxable estate when paid.

Case Study – IHT management in practice

Mr Example and his wife own three investment properties with a total value of £850,000.

They had both reached retirement age and are receiving both private pension income and state pension income. Therefore, they no longer required the rental income generated from their investment properties.

Mr and Mrs Example wanted to pass these properties onto their two children to give them some security for their futures, however they were aware that their portfolio pushed their IHT taxable estate over their available exemptions.

Therefore, they sought advice on the most tax efficient way to pass on their estate to their children.

We outlined all of the options available to Mr and Mrs Example including gifting and creating a trust. After explaining all of the benefits and considerations of all options we recommended that the properties were gifted outright to their children. This would completely remove the asset value from their taxable estate. This gift was classed as a Potentially Exempt Transfer (PET), meaning Mr and Mrs Example would have to survive seven years for the value to be fully removed from their estate.

Mr Example and his wife confirmed they were happy gift the properties to their children. They felt comfortable with this approach as their children are older and responsible, they also have the required knowledge to manage the properties at this point.

We established a protection policy to cover their children in the event that Mr and Mrs Example were to die within the seven year window.

The gift of properties removed a total of £850,000 of taxable capital from Mr and Mrs Example’s estate, saving them £340,000 in inheritance tax.

The protection policy was never required but if it was, the Example family would have been fully covered, ensuring that regardless of outcome, the family always retained the benefit of their assets, and nothing would be lost to the tax man.

If you would like any further information on the above areas or are looking for advice on any aspect of your financial plan, please do not hesitate to contact Jonathan Pryde of Chiene + Tait Financial Planning.

www.chienefinancial.co.uk

0131 370 8004

or alternatively email

jonathan.pryde@chienefinancial.co.uk.

The purpose of this article is to provide technical and generic information and should not be interpreted as a personal recommendation or advice.

Commercial Buy to Let mortgages and Tax Planning are not regulated by the FCA.