This article appeared in the Yorkshire Post on Saturday 30th June 2007.

Buying to Let Still Going Strong

Duncan Meredith Tax Consultant

The enthusiasm in this country for the ownership of property continues unabated and many people are still interested in acquiring property for letting. Some would say that this might not be a good plan at the moment, with rising interest rates and many areas where the market appears saturated and prices are very high. Nevertheless, there is still opportunity, although it is clear that it is necessary to keep a clear head and check out the numbers carefully. There is also the evergreen debate on which way the property market is going.

It is usual for the investor to be intending to acquire residential property but there is a growing interest in commercial property letting. This has some advantages, including potentially better capital gains tax (CGT) treatment. In this article, I shall concentrate on residential property acquired by individuals, which is not classed as ‘furnished holiday lets’.

When acquiring the property, it will probably be necessary to borrow. The ‘buy to let’ lenders will generally lend up to 85% of the cost of the property but the extra 15% (and ‘fit out’ costs) will have to be found from elsewhere. This may be available cash or perhaps a second loan on your own home; take care with interest costs and whether the rent will cover the borrowing, rates and insurance, as well as leaving something to cover repairs or unexpected bills.

In tax terms, the original purchase cost (including stamp duty land tax (SDLT)) will not be deductible against the rental income but will be stored up for the time when the property is sold. These costs will then feature in the CGT calculation. Some initial costs (e.g. bank fees for arranging the lending) will be deductible against income but the general theme is that annual costs only can be matched against annual receipts.

Examples of receipts and costs and their tax treatment are as follows (the key being to keep full records, including invoices):

Capital receipts and costs

• Proceeds of sale, less selling costs
• The total purchase cost, including SDLT, search costs and legal fees
• The cost of improvements (other than repairs)
• Refurbishing costs may be capital, if the property isn’t in a fit state to let out when you buy it

Income (revenue) receipts and costs

• Rent and associated charges
• Fees paid to agents to manage the property
• Tenant advertising costs
• Interest costs and bank fees connected with loans
• Buildings (and, if applicable, landlord’s contents) insurance
• Water & sewerage charges
• Council tax (exempt if occupied by students)
• Repairs (see below)
• Sundry costs (including stationery, mileage – but must be ‘wholly and exclusively for the purpose of the lettings business’)
• Accountancy costs, if applicable

There may be some doubt whether a repair is deductible, where it is a replacement asset or improves the original. For example, the windows may be single paned and are replaced with double-glazing. The general rule is that if the replacement is still a standard fitting, and it is the current standard item that has improved with the passage of time and the improvement of technology, then it is a repair. If it is a new asset, however small (e.g. an extractor fan), it is not a repair.

Another general rule is whether the replacement is of a part or is the whole. Old tax cases on this point centered on the replacement of chimneys. A small chimney on a roof was a repair; a stand-alone 180-foot chimney was not. You can see the line of thinking here, so a new fridge is not a repair.

In fact, for a furnished property there is an unusual method of getting a deduction for furniture and fittings. There is the choice of either nothing for the initial purchase then a deduction for the full cost of the replacement (‘the replacement basis’), or an annual reduction of the rent by 10% (the ‘wear and tear allowance’).

Profits from a rental business these days are calculated as if it were a trade, with income and expenses matched to the current period, not necessarily when actually received or paid. Losses can only be carried forward against future rental profits, not set against other income.

When it comes to sell, the tax treatment will be calculated under the CGT regime. The difference between the sale proceeds and the sum of all the capital costs will be taxed as a gain, subject to taper that increases with time (to a maximum of 40%). There is usually scope for planning to mitigate this, if considered early enough, particularly by efficient use of the CGT annual exemption.

Finally, property ownership is often seen as ‘pension planning’. However, its success breeds another problem, a growing IHT burden. Again, early attention is the best way to address this.

Duncan Meredith is a tax consultant at Garbutt & Elliott. Leeds (0113 2739600) and York (01904 464100). Duncan can be contacted at the York office, or by email to dmeredith@garbutt-elliott.co.uk.