Your property tax questions answered
In this article, we are going to answer the following questions about the allowable costs of property investments.
– What expenses can be claimed for a rental property?
– Do mortgage payments count as allowable expenses?
– What are the allowable expenses for landlords?
– Is decorating an allowable expense?
– Is stamp duty an allowable expense?
– Are letting agents fees tax deductible?
– Are all my house refurbishment costs tax allowable?
Whilst you are reading this article you may wish to read our page on the subject of “buy to let tax for UK landlords” where we discuss all the different types of tax that you need to be aware of. Read here for more (opens in a new tab)
Reduce Stamp Duty Land Tax when buying a rental property
Before I go into detail about the costs that may be allowed to reduce property profits and tax, I wish to discuss Stamp Duty Land Tax (SDLT). This type of tax applies to the bricks and mortar of a property. So if you buy an investment property even at the cost of £100,000 as a property investor, you will pay 3% SDLT surcharge. This is a cost of £3,000.
You do not pay SDLT on chattels. These items per the HMRC’s website are:
– items of household furniture
– paintings, antiques, items of crockery and china, plate and silverware
– motor cars, lorries, motorcycles
– items of plant and machinery not permanently fixed to a building
If you identify the costs of chattels costing say £10,000, then the SDLT will be reduced by this amount. At 3% the SDLT reduction is £300. This does not sound a great deal but it is another cost that is totally avoidable. All you would need to do is identify the cost of chattels with the seller and put these items on the conveyance documents.
SDLT costs are capital in nature. Therefore SDLT costs may not be offset against your rental income as a cost. Stamp duty tax deductable costs mean that you pay less Capital Gains Tax when the property is sold. This is because SDLT is a capitalised cost.
Identify chattels to decrease SDLT
Work with the seller to identify items that they wish to leave behind such as:
– Freestanding white goods
At the end of the day, you may be doing them a favour.
Any of the above costs that are subsequently skipped and replaced will be allowed to be offset against your taxable profits. This is provided the items are replaced like for like. Buying a plasma screen TV in place of a black and white TV will be capital as it is not strictly a like for like replacement as shown on HMRC’s website.
I will not spend any more time on SDLT but if it is of interest be sure to read our article.
Capital or revenue costs?
Costs incurred in a business can be categorised in one of 2 ways usually to help mitigate tax. These are:
1. Revenue costs (that can be used to reduce your tax bill). We will call these light refurbishment costs.
2. Capital costs (that can be used when you sell the property and can be set against the amount of gain made to reduce your capital gains tax bill).
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). Relief is only due under these special rules where the expenditure:
Qualifying pre-commencement expenditure
Qualifying pre-commencement expenditure is treated as incurred on the day on which the customer first carries on their rental business. This is deducted, together with the other allowable expenses of letting, from the total receipts of the business for that year.
– is incurred within seven years before the date the rental business is started, and
– is not otherwise allowable as a deduction for tax purposes, and
– would have been allowed as a deduction if it had been incurred after the rental business started.
Refurbishment costs will be considered to be capital if you are unable to get a buy to let mortgage. This is a good signal to suggest if the property is dilapidated or in a lettable state. If the property is lettable then HMRC will see like for life repairs/replacement as allowable to be offset against your taxable income. If the property does not have a buy to let mortgage then this tells HMRC that the property is dilapidated and that refurbishment costs are capital.
Allowable refurbishment costs to reduce your property profits and tax
There are three types of costs that are allowed to e offset against your property profits. These allowable refurbishment costs will reduce the tax that you pay to HMRC. Simply put the three Rs are:
You have a residential property with a buy to let mortgage. One of the terms of a buy to let mortgage is that it is in a lettable state. The same condition applies to HMRC. If the property is in a lettable state and has lighthouse refurbishment costs, these costs will be offset against your income.
I will caveat this tip. If the house refurbishment work is like for like then the cost is likely to be allowed per HMRC’s website. Costs of like for like replacements will be allowed if you have a 10 X 10 kitchen and replace eight kitchen cabinets and a standard fridge freezer with another. These costs will be allowed to be offset against your property rental income.
House refurbishment costs will not be allowed if you replace the same above kitchen but knock through a wall to install a much bigger kitchen with 20 cabinets and install an American fridge. These costs will not be allowed to be offset against your rental income. These costs will be deemed to be capital. As such these costs will be allowed, but only to reduce your Capital Gains Tax when you dispose of the property.
The issues with the decor of a house that you buy
Let us take a property that you have purchased. It is a property that has not been renovated for many many years. You know the types of property that have:
– The beautiful woodchip wallpaper
– The stunning salmon bathroom suite
– Furniture that looks as though it was leased from a museum. Yes, people still watch black and white TVs
– The kitchen sink that resides in a bedroom wardrobe (yes, this actually happened to me)
You know full well that the property would not achieve great rental income if let in its current state. As such you would replace the kitchen and bathroom suites and these costs provided they are like for like replacements (same number of cupboards and functionality). As such these items would be allowed to be offset against your property profits.
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.
There are times when it would appear that improvements have been made to a property. Many accountants would capitalise these costs. As HMRC’s website says “alterations due to advancements in technology are generally treated as an allowable repair rather than an improvement. If the functionality and character of the asset are broadly the same. For example, when single glazed windows are replaced with double glazing.”
As such 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
Section 24 – mortgage interest relief cap
Mortgage interest was an allowable cost to offset against your rental income. Things have now changed. Mortgage interest is no longer a tax allowable cost. You will now receive a 20% income tax reducer on the mortgage interest cost. Section 24 mortgage interest relief cap was a fundamental change to the tax planning of many UK landlords.
Property losses carried to offset against future profits.
A loss will be created if the house refurbishment costs exceed the income for the tax year. Any losses may be carried forward and used against future property profits, which is what Louise and I did with our property portfolio. We used to boast that we did not pay tax on our property profits for six years.
The reason we did not pay tax for this number of years is that we purchased 1-2 properties per year and made sure that we spent £10,000 per property on tax allowable refurbishment costs.
Capital costs when refurbishing a property – offset against your capital gains tax liability
The refurbishment costs as shown on HMRC’s website and listed below will be considered to be capital in nature. These costs will not be allowed to be offset against your property profits
– expenditure which adds to or improves the land or property; for example, converting a disused barn to a holiday home
– the cost of refurbishing or repairing a property bought in a derelict or run-down state,
– expenditure on demolishing a derelict factory to clear space for a new office building; the cost of the new building,
– the cost of building a car park next to a property that is let,
– expenditure on a new access road to a property,
– the cost of a new piece of land next to a property that is let.
It is essential that you keep your receipts for the entire period that you own the property. Once you sell the property, you will need to produce a capital gain schedule, which is the difference between the sales price and purchase costs (including capitalised refurbishment work).
We will not go into detail here about Capital Gains Tax. More can be read here on that subject.
Reduce the costs of your property refurbishment
It is important that you ensure you remain profitable. The more control you have over your refurbishment costs the more profit you will make. This, in turn, will help you increase the Return on investment (ROI) that you make. I have written a useful article on this here.
There are two aspects of your property refurbishment costs that you can control.
The labour costs of your tradespeople will be important to control. We suggest that you obtain 2-3 quotes for any job that is more than £5,000. Anything less may cost you valuable time and mitigate any potential savings by getting quotes.
You need to be specific as possible and consistent with your requirements. This I would like to call comparing apples with apples. You should expect two different quotes if you provide one tradesperson with a specification but the second tradesperson is provided with another.
Another way to manage your profits and ROI is to ensure that you ensure value for money on the materials that you buy. This does not mean that you scrimp on quality but you shop around for the same quality items at different outlets.
We recommend that you consider becoming a member of LNPG as you will secure significant discounts on your refurbishment items such as kitchens, bathrooms, paints etc. You get a 10% discount on your first annual fee if you quote OP10.
Cost V quality of your property investment refurbishment
I cannot overstress the importance of quality. If you have a high standard property with excellent interiors, you can command higher rents. You can only compete on price if you have two properties that are identical to standard furniture and magnolia walls in the same street.
Whenever I have a refurbish a property, I make sure that it is the best in the local area never mind the street. This is because I wish to attract nice tenants that will feel pride and joy in the property. I am hopeful that if I have a happy tenant that they will look after my property. There are three main benefits of having happy tenants:
– Voids are reduced as tenants will stay in the property
– Maintenance costs are lower because the tenants will look after them. Even when the tenant leaves
I am also hopeful that happy tenants that eventually leave the property will do so in good condition so that I can move the next tenant in without much work being done.
The issue I see with many property investors is that they focus on the price of the refurbishment. There is an error in judgement by lowering quality standards to reduce costs, which they believe will increase long term profits. The fact is that cheap kitchen cabinets that break requires maintenance. This means a few things
The real cost of going cheap on your property refurbishment
– Time: Your time is absorbed by managing the repairs between the tenant and the maintenance person
– Money: The repair costs of labour and materials on the first maintenance work has cost you more than if you bought a quality kitchen in the first place
– Unhappy tenants: No one likes inconvenience and this also applies to tenants. Tenants will start to be unhappy if they have to call you more than once because of faulty items and they have to wait in for the maintenance person. At some point, they will start to look for a better quality property.
Quality refurbishment to increase property profits
I was fortunate enough to come by a gentleman called Julian Maurice. He runs a company called Icon Living. He introduced me to the fact that each property ought to look like a showroom. There are a lot of properties out there with the same boring standards. Adding the below provide tenants with a sense of moving from home to home. This allows them to justify to themselves that the extra rent is worth it.
– A splash of colour to be remembered. No more “Plain Jane” magnolia walls. Design a house/room to be stylish and homely.
– A painting that captures the imagination. Make sure your property is memorable over and above everyone else’s.
– Furniture to die for. Stunning pieces of furniture that amaze potential tenants will ensure that it is looked after. The best types of furniture are those that are built into the property. Examples being wardrobes to white good items such as microwaves, fridges and ovens
– Functional: In addition to beauty if you have students renting your property be sure to ensure that they have sufficient space to do their work. Having nice big desks with drawers is ideal. If you have a quiet room even better.
Other tax allowable costs for property investors
I often find that people buy cars without necessarily thinking about their cash flow or need their tax position, be it employees, business owners or property investors. Many people will buy a brand new car because they love the feeling of treating themselves to something new. After all, you deserve a reward for all your hard work. The issue with this is the value. As soon as you drive a car a few miles away from the forecourt you ought to know that the value of the car drops in value by 20%+.
Equally, there are people that go for a company car or buy a car in their own company name and have all their fuel paid. This seems like a great idea because the company makes all the payments. The issue with this approach is that you are taxed quite heavily for the car value and fuel known as HMRC: Benefit in Kind (BIK)
Can you relate to the above?
Can you see how buying a car in the wrong structure may be damaging to your cash flow/tax position?
If you have answered yes to these questions then this article will be an interesting read.
1. It is better for cash flow to get a lease rather than forking out for a brand new car that simply is depreciated as soon as you drive it off the forecourt
2. You can often get full maintenance leases, which means you do not pay out for wear & tear repairs/maintenance.
3. You will not be taxed as having a benefit in kind (BIK) if you pay for the car. BIK will be more costly, from a tax perspective, than claiming mileage.
Practical steps you should now take to lease a car and claim business mileage
It is one thing to understand the theory but it is another to put it into practice. This is why I have written a step by step guide to implement this strategy
1. Put the lease car in your personal name
2. Claim mileage for using the car. Mileage is an allowable expense to reduce the tax bill that will help you reduce your business/property income
Travel & subsistence costs
The typical types of costs you can claim for are and must be supported by receipts and are wholly, exclusively and necessary for the purposes of your trade activity are:
– Buses, trains, planes
– Hotel accommodation
– Tolls and car parking
– Business phone calls, internet charges (hotels or another mobile)
– Professional fees
– Home costs *
£5 Breakfast rate given if an employee leaves their house before 6am
£5 meal rate where an employee has been away from the usual place of work for more than five hours
£15 meal rate whereby the employee is working after 8pm and eats whilst working
More details on this may be found on the government website.
You can claim up to £312 per year for your home costs against your trade business/property income. You do not need to provide any records of the household expenses you’re claiming relief for.
For amounts above the £312 amount, you will need supporting evidence. This is to show HMRC that the amount you are claiming is no more than the additional household expenses you have actually incurred.
Our concern with this approach is that HMRC could argue that a room used for an office becomes chargeable to CGT if you later sell the property. This is why we suggest claiming the £312 is sufficient enough without causing you a potential CGT liability in the future.
Alternative finance arrangements
As shown by the HMRC website, it is possible to get tax relief on loan interest that is incurred for business purposes.
You may be able to claim tax relief for loan interest paid. This also applies to alternative finance interest payments.
Interest may be tax-deductible where the loan or alternative finance arrangement is used to:
– Buy ordinary shares in, or lend money to, a close company. This is where you own more than 5% of the ordinary share capital.
– Buy ordinary shares in, or lend money to, a close company. When you own any part of the share capital and work for the greater part of your time in the business
– Acquire ordinary share capital in an employee-controlled company. This applies if you are a full-time employee. A full-time employee is when you work for the greater part of your time as a director or employee.
Alternative finance arrangement – What you must also do…
– Acquire an interest in a trading or professional partnership including a Limited Liability Partnership (LLP). Provided it was constituted under the LLP Act 2000, other than an investment LLP.
– To provide a partnership, including an LLP with funds by way of capital or premium. It could also include advancing money. The money wholly for the partnership’s business
– Buy equipment or machinery for use in your work for your employer, or by a partnership (unless you have already deducted the interest as a business expense). Relief is only available if you, or the partnership, were entitled to claim capital allowances on the item(s) in question. Only the business proportion of the loan interest or alternative finance payments qualifies for relief if the assets are only partially used in the business.
– You should enter the interest on loans and alternative finance payments, under an alternative finance arrangement to buy or improve rental properties, on the UK property pages.
Please note – what you cannot do to claim an alternative finance arrangement
You cannot claim relief for interest on overdrafts or credit cards. Ensure that you get (and keep) from your lender a certificate of interest. You will also need receipts for the alternative finance payments you have paid during the year.
Tax relief is restricted when you are claiming income tax relief on the interest. The limit on Income Tax reliefs restricts the total amount of qualifying loan interest relief and certain other reliefs in each year to the greater of £50,000 and 25% of ‘adjusted total income.
HS340 Qualifying Loan Example 1
Phil has a total income of £70,000 and makes a trading loss in that year on one of his businesses of £60,000.
The maximum amount of relief Phil can set against his total income for 2017 to 2018 is £50,000 as this is the greater of £50,000 and 25% of his income. The remaining £10,000 loss can be carried forward.
Order of reliefs
As shown by the HMRCs website, loan interest losses are restricted. Where the total of losses and loan interest payments exceeds the limit, it can be beneficial to have the maximum possible loan interest payments set against income in the given tax year. This is because these payments can’t be carried forward or back and they would otherwise be lost.
HS340 Qualifying Loan Example 2
Paul has a total income of £90,000. His share of partnership trading losses is £49,000. He has also paid £6,000 interest on a business loan.
Only £50,000 of his combined losses and loan interest can be used to reduce his taxable income.
Paul, therefore, specifies that the full £6,000 loan interest is to be relieved first. Only £44,000 of his partnership trading loss is then used. The remaining £5,000 of these losses is carried forward to set against partnership profits.
Had he specified that the £49,000 partnership trading losses are relieved first he could only have used £1,000 of the loan interest and the balance would have been lost.
How does this affect Hong Kongers that are looking to move or invest in the United Kingdom from Hong Kong?
Hong Kongers that invest in UK real estate property does not need to worry about another tax in Hong Kong. That is because the Inland Revenue Department in Hong Kong does not charge tax on foreign investments.
Learn more about our International services to help Hong Kongers move or invest in the United Kingdom
How does this Americans readers that are looking to move to the United Kingdom from the United States?
The IRS in the United States does not have the same tax reliefs as HMRC in the United Kingdom. For instance, the replacement costs of an asset in the UK will be allowable to reduce your UK income tax. The IRS does not allow for property repairs costs to reduce your tax liability. In fact, repairs are classified by The IRS as capital costs in nature and will not get tax relief. As such you are likely to have a greater tax charge on the rental profits in the United States due to the greater profits, simply due to the different tax treatments of allowable costs.
There are many more examples of how The IRS and HMRC differ in their tax treatments. It is therefore vitally important that you work with an international tax advisor to help you understand what costs are taxable in the United Kingdom and what property costs are allowable by the IRS in the United States of America.
Learn more about our International services to help Americans move or invest in the United Kingdom
How does this affect our British readers that are looking to move or invest in either the United States or Hong Kong?
British people that wish to live abroad need to appreciate the international tax simplification of their UK rental profits. There are no tax issues in Hong Kong on any UK profits. However, as shown above, The IRS will charge tax on your worldwide assets if you are a US resident. This means that you need to think carefully about the amount of tax that you pay on your properties in both the United Kingdom by HMRC and the United States by the IRS.
Do not worry as you will receive a tax credit or a tax deduction on the tax paid to HMRC in the United Kingdom. You will need to speak with your international tax advisor to ensure that you choose the most tax-efficient option, be it, the tax credit or the tax deduction.