How to make sure your rental purchase is still profitable

  • Investing in rental property is no longer as tax-efficient as it used to be
  • But there are always ways to reduce the amount of taxes and expenses you incur when doing this.
  • If you choose the right area and buying real estate can still be a worthwhile investment

Investing in real estate comes with its own unique challenges, and its appeal has waned in recent years following changes in tax breaks and regulations. The impact of the pandemic has also dented landlord profits with the introduction of emergency tenants protections, which include a ban on evictions, rent cuts and paid holidays during a series of lockdowns. Homeowners can now recoup lost income amid uncertainty over the future of the rental market and the possibility of further coronavirus restrictions.

Changes to tax benefits since 2017 have already affected profits, for example by reducing the amount of mortgage fees that can be deducted from rental income. Homeowners and owners of second homes must also pay a stamp duty surcharge of 3 percent. The government had planned to increase the surtax to 4 percent in the fall budget, but no increase has yet been implemented.

Sarah Coles, Senior Personal Finance Analyst at Hargreaves lansdown, says: “Thanks to tax changes, owning rental property is one of the least tax efficient ways of investing. You pay taxes on entry, as you sell, severely reducing your profits. “

At the same time, the recent increase in bank of england base rate of 0.1 percent to 0.25 percent is likely to be passed on to real estate investors in the form of higher mortgage rates. Lenders typically need rental income to cover at least 125% of monthly mortgage payments, although they vary in their approach.

Fortunately for real estate investors, the cost of rent and demand from tenants have increased. Over the past year, rents have increased at their fastest pace in over a decade. According to the site of the establishment Zoopla, UK rents were 4.6% higher in September 2021 than a year earlier, averaging around £ 968 per month. Some parts of the UK still offer yields of over 7%, including Hartlepool, Middlesborough and Liverpool.

Coles says: “In the South West and East Midlands demand is driving rental prices up dramatically. Meanwhile, in London, rents are dropping as workers move out of the city and short-term rentals convert to long-term rentals, flooding the market with new properties.

Real estate agent Hamptons predicts that the pace of rent increases will slow in 2022 and forecasts average growth of 2.5% over the next 12 months. Generally speaking, however, real estate experts agree that the imbalance of supply and demand in the rental market means that the cost of rents will continue to rise.

So, despite the challenges for the sector, there may still be opportunities for income-seeking homeowners who choose the right area and property to attract tenants.

There are also ways to reduce your taxes. You can still deduct 20% of mortgage interest from your tax bill, although that’s not as good as when higher rate taxpayers could get 40% relief.

Offsetting expenses against profits

Landlords can offset all expenses “wholly and exclusively” associated with the rental of a property. For example, these can include travel costs to rental properties and advertising costs.

“You can always offset certain expenses, including water tariffs, council tax, gas and electricity, building insurance, the cost of services like gardeners and cleaners, utility costs. rental agent and managing agent, general maintenance (but not improvements) and accountant fees, Coles says.

If tenants have not been able to pay their rent during successive lockdowns, the loss of rental income can be offset by your next tax bill. If you own a rental property that has been unoccupied for months, leaving you to bear housing tax and energy bills, these additional costs may also be claimed on tax returns.

Hold property through a public limited company

Owning rental property through a public limited company has various tax advantages. All mortgage interest can be deducted from tax, and businesses do not pay capital gains tax (CGT) when they sell property. Corporate tax, which currently stands at 19 percent, is levied on profits rather than income tax. Personal income tax rates are 20%, 40% or 45%, depending on which tax bracket you are in.

“If you are buying through a limited liability company, the mortgage interest can be treated as a cost that is offset by the profits,” Coles explains. “Tax rates may also be lower than income tax on rent. However, you will also be taxed on any income you receive as wages and any income you receive as dividend, after the annual deduction. for dividends. [of £2,000]. You also pay more for a commercial mortgage and have to foot the bill for all costs associated with running the business.

However, Mark Harris, managing director of the mortgage broker SPF Private Customers, says, “Limited business loans are more expensive, but with the growth of competition, even these specialized rates are getting cheaper. It’s worth consulting with a mortgage advisor who can help you find the best products and who potentially has access to only middle-of-the-road products.

However, if you already own properties for rent, you will need to effectively sell them to the limited company, which will likely result in a tax bill. The exact position depends on your personal situation, so if you are interested in owning rental property through a public limited company, consult a tax professional who can advise you on the implications and the best strategy for your situation.

It is also important to note that if you have a portfolio of properties held through a limited company, you could be affected by tax increases. Corporate tax is reduced from 19% to 25% in April 2023 for companies with profits over £ 50,000.

Switch to a vacation home or sell

If a property for rent doesn’t turn out as lucrative as you hoped or needed, you can sell it or turn it into a vacation home. Vacation rentals have the potential to provide a higher income than rentals, although you have to work hard to market them and secure bookings.

If you rent a furnished rental property, you benefit from numerous tax advantages. Vacation rentals are treated as a business rather than an investment by HM Revenue & Customs, so that mortgage interest charges can be deducted from any income for tax purposes. Housing tax, utility bills and repair costs can also be charged against income, before tax. However, the units must be available for rent for at least 210 days per year and rented at least 105 days per year, although they cannot be rented on a long-term basis.

Vacation rental income is treated as business income, so capital deductions may be available for items such as furniture, equipment, and fixtures. Income from vacation rentals can also be invested in a pension and receive tax relief, unlike income from rental properties.

CGT debts resulting from the sale of a seasonal rental are renewable. So if you sell one vacation rental and reinvest the proceeds in another, any gain on the first may be deferred until you sell the second. However, if you already own another residential property, a 3% stamp duty surcharge applies when you buy a property, whether it’s a vacation rental or hire purchase.

Whether or not to invest in real estate is worth it depends on your personal circumstances, so you need to do the math to establish it. Gareth Lewis, Commercial Director of the Real Estate Lender MT financing, says: “A growing number of real estate investors are looking to reorganize their portfolios or even sell them. This in turn will open up new opportunities for investors to buy property, allowing them to take advantage of the current price growth and low interest rates. “

If you are selling a property, be sure to deduct fees such as realtor fees and attorneys’ fees from your CGT bill. You can also include money spent on major work such as a loft conversion or extension. And you will also be able to substantially reduce your CGT bill if the property was at one point your primary residence.

It’s harder than it used to be to profit from brick and mortar, but it can still increase your income, depending on your financial goals and personal circumstances.

Possible tax changes on the horizon

Further changes and regulations could be forced on homeowners, and there are fears that CGT rates will rise to cover the huge sums of money the government has spent to deal with the coronavirus pandemic.

The Office for Tax Simplification, for example, has proposed that the annual CGT abatement – the amount of profit you can make before you have to pay this tax – be reduced from £ 12,300 to £ 2,000. Base rate taxpayers are currently billed 18% CGT for sales of investment property or second homes, and higher rate taxpayers 28%.


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