Questions answered about Investment Property Due Diligence Checklist
As property accountants, we are regularly asked questions about property investments. We will look to answer the below questions in this article.
– What property should I buy?
– Where should I buy the property?
– Should I buy a new property or a property to be refurbished?
– What are the purchase costs considerations including SDLT?
– What are the refurbishment costs considerations?
– What tax structure should I buy the property?
What property should I buy?
As property tax specialists we know that there are many reasons why landlords purchase buy to let properties.
It is important to know what you want out of the property. For instance
– Capital growth: Is your intention to buy a property that will provide you with a pension lump sum when sold in later years
– Income: You may be looking to generate an income from property. The property income may be supplementary to your current income streams or a replacement of your employment income.
It is important that you are clear about your long term objectives from the outset about the above before you purchase any buy to let property investment. It is tempting to listen to other people and invest in the same type of property.
As the late great Stephen Covey once said: “Make sure you do not put your ladder up against the wrong wall”. You need to buy the property that best suits your objectives.
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Where should I buy the property?
Location, location, location…
This question may be partly answered by the answer you provided to the previous question “What property should I buy?”.
You may wish to buy a property in the south of England or in an area that is going through a lot of development if you are banking on capital growth.
You may not want to invest in the South of England if you were looking for a double-digit return on investment on a single let property. You may get better returns on your investment not the further up the country.
That said, there are many UK landlords that wish to invest and manage the properties themselves rather than use a letting agent. It would not be wise to buy an investment in London if you live in Manchester given the time of commute just to show a tenant around the property.
It is important that you research the counties, cities and then the towns of the areas that you are interested in You can read national and local authority news about developments in that area.
Tenants are your customers. Make sure you understand what their needs are. Do they need:
– Good transport links
– Local shops
– Parks or community centres
– Quiet or active areas
– Business or leisure-focused
The more boxes you the tick the greater rent that you can charge.
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What tax structure should I buy the property?
It is quite amazing that people automatically link a property purchase with a limited company without really thinking of their own individual requirements and unique tax position.
We have written an article that discussed the use of a limited company when investing in property, please go ahead and read that later.
There are many advantages of using a limited company to invest in buy to let properties
– Section 24 mortgage interest relief cap does not affect buy to let properties within a limited company. All of the interest costs may be offset against the income.
Section 24 means that you are not allowed to offset mortgage interest costs against your residential rental income. This means you make an artificial profit, which HMRC tax you. There is a 20% tax reducer on the mortgage interest costs but it does mean that most landlords will pay more tax.
– Corporation tax rate is 19%. This is less than the 20% income tax band. You would pay a higher rate of 40% for high rate taxpayers and 45% for additional rate taxpayers.
There are disadvantages to owning buy to let investments inside of a limited company
– Mortgage interest rates are 1% if not 1.5% more in a limited company than they are in your personal name. Do speak with your mortgage broker about interest rates as they vary due to the tax structure and type of property.
– You have double amount of accountancy costs. You need to submit a personal self-assessment tax return as a property investor, which would carry on as a director of a limited company. In addition, you also have to file a limited company set of accounts to Companies House and a company tax return to HMRC
– You are paying tax twice. A company will pay 19% corporation tax and you will also pay income tax on the money that you take out of the company (7.5% basic rate, 32.5% high rate, 38.1% additional income tax on dividends). The first £2,000 dividends are tax-free
– Missing out on personal tax advantages. A company does not get a tax-free band. As individuals, you get an allowance of £12,500 before you pay any income tax without the need of a limited company. If your spouse is not working it would be better to allocate property income in their name via a deed of trust to gain the personal tax band advantage.
Many people think about setting up a limited company because they are employed and are high rate tax earners.
What about in 5 years time?
It would be useful to purchase properties in a limited company If you foresee that you will remain employed as a high rate taxpayer and will reinvest the majority of the rental profits.
It would be useful to purchase properties in your own name If you expect to leave your employed job within the next five years. Take the tax hit now but benefit from lower mortgage interest rates and lower tax once you have left your job.
Should I buy a new property or a property to be refurbished?
You can buy a brand new property, which does not need any work being done to it. It is likely that you pay a premium for buying a brand new property if you have not negotiated with the property developer.
The advantages of buying a brand new property are (in most cases)
– The property is ready to let
– No time is taken doing the property up
– Warranties are in place in the event of something going wrong
Below Market Value properties – tired and in need of TLC
You may have comes across the phrase “Below Market Value” or “BMV”.
There are many reasons why you might buy a property BMV. One of the reasons you might be able to buy a BMV property is the condition it is in.
One of the negotiation tactics I deploy is to speak with the seller and start with the market value of the property if it was in mint condition. I then work backwards to a value based on the amount of money that I need to spend on the refurbishment to get to that mint condition.
I buy properties in Nottingham and usually buy a house from an older couple that is looking to downsize. They may not have done any work to the property in the last twenty years, leaving behind the lovely salmon coloured bathroom suite and the rickety wooden kitchen cabinetry
Let me take you through an example
£200,000 is the property value in minty condition
£10,000 minimum profit I wish to make on the purchase of the property (say 5%)
£30,000 is the amount of work I need to spend on the current property
I know that I want to buy the property with a value of £160,000. I take them through the cost, time and effort of doing up the property. I would start the bidding price at £150,000 giving them the psychological comfort of pushing up my offer price.
Refurbishment allowable costs to reduce property tax
One of the advantages of buying properties below market value is the ability to offset the refurbishment costs against your property income.
There are many accountants that suggest that the initial cost of refurbishment costs are capital. This would suggest that the initial refurbishment costs can’t be used to offset against your property income at all and would be considered to be capital.
Capital costs would not reduce your rental profits, this tax. Capital costs would still be beneficial as it reduces the profit when you sell the property at a later stage. All is not lost but income tax is traditionally more than capital gains tax so it is better to offset refurbishment costs sooner rather than later.
As HMRC’s website states that refurbishment costs are allowed provided that the property is in a lettable state. To quote HMRC’s website “A property acquired that wasn’t in a fit state for use in the business until the repairs had been carried out or that couldn’t continue to be let without repairs being made shortly after acquisition.”
A customer may incur expenses for the purposes of a rental business before that business starts. If so, they may be able to claim a deduction for them once the letting begins (ITTOIA05/S57 or CTA09/S61).
Allowable refurbishment costs to reduce your property profits and tax
There are three types of costs that are allowed to be offset against your property profits. These allowable refurbishment costs will reduce the tax that you pay to HMRC. Simply put the three Rs are:
a) Replacement (kitchens, bathrooms and furniture)
b) Repairs (roof tiles, garden fence, brickwork)
c) Renewals (replastering, repainting)
You know full well that the property would not achieve great rental income if let in its current state. You would replace the kitchen and bathroom suites and these costs provided they are like for like replacements (same number of cupboards and functionality).
Once you have replaced these items, you may turn your attention to the decoration. You will be able to claim 100% of the costs if you renew the paintwork and plasterwork to make them look shiny and new. The same applies to the replacement curtains, carpets and furniture as I have mentioned before.
The fact that you replace boilers, plumbing, wiring etc. these costs will be allowed to be offset against your property profits. These costs help you reduce your property tax bill
We have written a much more details article about the allowable refurbishment costs to decrease your property tax, go ahead and read that.
A note on Stamp Duty Land Tax when buying a buy to let property
There is a nice easy way to reduce SDLT when purchasing a buy to let property as a landlord.
You pay SDLT on the bricks and mortar of the property.
Identifying fixtures/fittings and furniture = chattels (means you do not pay SDLT)
– £200,000 property value
– £10,000 (F/F and F = settee, tables, freestanding kitchen appliances
– £190,000 which is used for SDLT purposes not the £200,000 thus saving SDLT.
You would walk around the property with the seller and identify the below that may be left behind. You ask them the question “how much did you pay for this…”. It is this price that helps you to document the chattel and reduce SDLT
– Curtains & curtain fixtures
– Light fittings
– Furniture & other fixtures
It is important that the seller’s solicitors and your solicitor identify chattels and document them correctly in order for the reduction of SDLT to take place.
A secondary note on Stamp Duty Land Tax
I would always suggest that you check the SDLT calculations performed by the conveyance solicitor. Our property accountants have managed to work with our clients and their solicitors to reclaim overpaid SDLT for a number of reasons.
We have written a great article that discusses the Stamp Duty Land Tax (SDLT) considerations for a property investor, which will help you get a better understanding and reduce SDLT at the same time.