Buy to Let - Market Investments - Essay Example

Running head: BUY TO LET INVESTMENT MARKET Buy to Let Investment Market [Click here and type [Click here and type your s Buy to Let Market Investments The Buy to Let Market has been around since the early nineties and has been a successful addition to many investor's portfolios. "The Council of Mortgage Lenders (CML) started collecting statistics on buy-to-let in 1997 and some observers have interpreted the growth in buy-to-let lending, as reported by the CML, as evidence of a boom. However the CML only measures the growth of the new specialist lenders in the market - such as Paragon Mortgages, Mortgage Express and BM Solutions, whilst omitting the core back book of loans to residential property investors by mainstream lenders." (Wikipedia: Buy to Let) This paper will focus on four areas of the buy to let marketplace: explanation of the taxes a property investor will be subjected to, how the property investor can minimize their capital gains tax liability through careful tax planning, how to be careful not to attract an investigation by the Inland Revenue, and, the tax benefits of setting up a property company to save property tax. Impending Buy to Let Taxes There are a variety of taxes that the investor will be required to consider when investing in buy to let properties including: stamp duty and inheritance tax. There are some taxes that can be reclaimed against the tax on rents for buy to let properties such as "costs of maintenance, such as insurance, cleaning, gardening, agent's commission and other reasonable management expenses (but not home improvements) and a wear and tear allowance of 10% of the rents received may be deductible." (Alan Harvey, 2006) Stamp duty, as outlined by Weller and McTernan (2006) from their book How to use companies to cut your property tax bills, explain that stamp duty is liable when, land or residential property is purchased where where the purchase price is above 60,000, or where it is transferred and the outstanding mortgage amount is greater than 60,000. The rates of stamp duty vary between 1% for properties less than 250,000 and 4% for properties over 500,000. It is also worth noting that there are certain areas that are exempt from stamp duty, where the property is purchased for less than 150,000. (Weller and McTernan, 2006) The other tax that the investor will be responsible is inheritance tax which is commonly referred to as the 'gift' or 'death tax'. Weller and McTernan (2006) explain the inheritance tax: if at the time of your death you pass on part or the whole of your estate then again the inheritor could be liable to pay Inheritance Tax. There is currently an IHT threshold level of 263,000 for the 2004-2005 tax year. Anything above this amount is taxed at 40% i.e. at the highest rate. This means that if at the time of death, your whole estate is valued at less than 263,000 then the inheritor will have no tax to pay. (Weller and McTernan, 2006) The two things you can't escape are death and taxes, but, why not make an investment work for the investor. By buying into the buy to let scheme, an investor's main goal is to gain equity buy minimising what they will pay to the Inland Revenue department. The investor's objective is to minimise their capital gains tax liability through careful tax planning. Minimising Capital Gains Tax Capital gains tax is payable "if a property is sold for a higher price that what was paid for it, or when a property or part of a property is transferred to someone who is not your spouse." (Weller and McTernan, 2006). Thus "the capital gain is calculated by deducting the allowable costs and Inland Revenue tax relief's, from the selling price of the property. Examples of allowable costs include, property extensions, purchasing related costs etc." (Weller and McTernan, 2006). As some investors fail to realise that when they sell their property, they could end up paying an extremely large tax bill of anywhere up to 40% of the net profit of the sale of the property. For instance, if you sell a property with a capital gain of 100,000, then 40,000 could go directly to the Inland Revenue department. There are two tax saving measures to minimise this capital gain or, even wiping it out. As explained by Weller and McTernan (2006), these methods are: private residence relief and joint ownership of property between husband and wife. Private Residence Relief This is available if this was your main residential property and has been claimed as such. If this has been your main residence throughout the existence of the property ownership, you can claim full residence relief and will then produce no tax liability upon the sale of the property and vacating its premises. One of the main common usages by many investors is the partial residence relief. This relief can be claimed if you used the property as your main residence, but then also moved out of the property whilst still retaining ownership i.e. the property was rented out. In such a scenario, no capital gains tax will be liable for the duration that the property was the main residence and for the last three years of ownership. The latter is covered by the '36 Month Rule'. A growing number of property investors are using the '36 Month Rule' to their advantage. When a new property is purchased, they are renting out the existing property and moving into the new one, thus allowing for another three years of tax free capital growth. (Weller and McTernan, 2006) The second capital gains tax reduction method is the joint ownership of property between husband and wife as desribed below by Weller and McTernan. Joint Ownership of Property This is an extremely advantageous tax planning method is to hold property jointly between husband and wife through the annual CGT allowance for both upon the property being sold. This is currently set at 8,200. By jointly sharing the property title, "it is also beneficial if one is a lower rate taxpayer than the other. In this case it may be beneficial to hold a greater share of the property in the name of the lower-rate tax payer." (Weller and McTernan, 2006) When the property is finally sold, the reduction in capital gains tax bill will be advantageous as well as any potential ongoing tax liabilities that may need to be reported. Another advantage to this method of joint ownership is that properties "can be transferred between husband and wife freely without triggering a CGT liability. This means that some smart tax planning can lead to a greatly reduced tax bill." (Weller and McTernan, 2006) Investing Without Attracting the Inland Revenue There are many techniques that the Inland Revenue utilise in catching those suspicious of investment fraud. I will discuss some of them here: Pot Luck - This is a case of the Revenue randomly picking a return based on no definitive criteria. This is just luck of the draw. This is a commonality throughout the Revenue system in an effort to ensure that certain groups of individuals are not continually targeted for Audit or review of their claims. Third party informers - The Revenue depends on the use of innocent revenue filers that, for instance, claim rental income they have paid and Revenue will attempt then to match this up with what their Landlord has claimed. This helps the Revenue weed out those who are deceitful. New stamp duty and land tax returns - Through matching up new stamp duty land tax returns, "the Revenue will soon build up a powerful database to supplement the information held at the Land Registry so that they can find out who owns more than one property. They will also be able to track sales and purchases." (Weller and McTernan, 2006) Computers and statistics - "The Revenue has another tool in their armoury, and this is the statistics they have built up as a result of the self assessment system and the computerisation of records. These systems track and automatically flag for enquiry any entries in a Return that fall outside the statistical norm." (Weller and McTernan, 2006) The analysis of this process used by Inland Revenue to catch those who are not completely and legitimately truthful in their buying and selling their property will only find them a target of the Revenue. When deciding on a buy to let scheme, it is best to completely investigate all legal implications as well as the tax savings or tax indebtedness of this investment. Tax Benefits of Setting Up A Property Company The following are identified as benefits of this process by Ian McTernan: The first 10,000 that a company makes is tax exempt which means that you will not have to pay any Company tax on profit that is that is equal to or below this threshold level if the money is retained within the company. Lower rate tax saving: as a higher rate taxpayer, you pay 40% on your profit and gains. For a limited company the tax rates are between 0% and 30% - a considerable saving. Stamp Duty Savings: you only pay stamp duty at a rate of 0.5% when purchasing company shares. A company can define its own accounting period that does not exceed 18 months. You only pay stamp duty at 0.5% when purchasing company shares. Indexation relief is still available for any capital gains. Lower tax rates, as companies pay tax between 0% and 30%. The first 10,000 a company makes is tax-free if the profits are retained within the company. Properties can be transferred within companies without incurring a tax liability. You can grow a portfolio quicker within a company by continuing to re-invest the profits and thus deferring any tax. Dividends can be extracted from a company in a tax efficient way. (Weller and McTernan, 2006) The drawbacks of this process, also identified by Ian McTernan are: Companies cannot use the annual personal CGT allowance. This allowance is 7,900 for the tax year 2003-2004. Official company accounts must be produced. The cost of drawing up such accounts can be 3-4 times more expensive than having your sole-trader accounts drawn up. Banks are less reluctant to lend money to you if you are purchasing through a company. (Weller and McTernan, 2006) Conclusion There are many positive advantages of the buy to let investment scheme and through careful planning prior to calling the investment counsellor, the savvy individual investor can find themselves in a positive financial situation. Many seasoned investors have found that buying property can be a rewarding and positive experience where different tax advantages, as outlined in this paper, are waiting for that next potential buyer. A successful buy to let investor can only be so by remembering the four areas of this paper's focus respecting the buy to let marketplace: explanation of the taxes a property investor will be subjected to, how the property investor can minimize their capital gains tax liability through careful tax planning, how to be careful not to attract an investigation by the Inland Revenue, and, the tax benefits of setting up a property company to save property tax, the marketplace can be as successful as the investor. Through the due diligence of proper reporting of investments, the investor can also reap many rewards that have become a market mainstay since the early nineties and as such will continue with smart business practices on behalf of the investor and their agent. References Harvey, Alan. Buy to Let. Alan Harvey Property Services. Retrieved February 19, 2006 from http://www.alanharvey.co.uk/sales/buytolet.htmlcart=110774678685845032 Property Tax Portal. [online]. Retrieved February 19, 2006 from http://www.property-tax-portal.co.uk/tax_saving_strategies.shtml Weller, Arther and McTernan, Ian. (2006) How to use companies to cut your property tax bills. Retrieved February 19, 2006 from http://www.taxationweb.co.uk/articles/article.phpid=92 Wikipedia contributors (2005). Buy to let. Wikipedia, The Free Encyclopedia. Retrieved February 20, 2006 from http://en.wikipedia.org/w/index.phptitle=Buy_to_let&oldid=33084996 Read More