How to ensure your buy-to-let still makes a profit

Investing in property comes with its own particular challenges, and its attraction has diminished over recent years following changes to tax relief and regulations. The pandemic’s impact has also dented landlords’ profits with the introduction of emergency protections for tenants, which include a ban on evictions, rent reductions and payment holidays during a series of lockdowns. Landlords may now be clawing back lost income amid uncertainty over what lies ahead for the rental market and the possibility of further coronavirus restrictions.

Tax benefit changes since 2017 have already affected profits, for example, by reducing the amount of mortgage costs which can be offset against rental income. Landlords and second homeowners must also pay a 3 per cent stamp duty surcharge. The government had planned to increase the surcharge to 4 per cent in the Autumn Budget, but no hike has yet been implemented.

Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, says: “Thanks to tax changes, owning a buy-to-let property is one of the least tax-efficient ways possible to invest. You pay tax on the way in, as you go along and when you sell up, which severely dents your profits.”

Meanwhile, the recent increase in the Bank of England base rate from 0.1 per cent to 0.25 per cent is likely to be passed onto property investors in the form of higher mortgage rates. Lenders typically need rental income to cover at least 125 per cent of monthly mortgage payments, although they vary in their approach.

Fortunately for property investors, the cost of rent and demand from tenants has been rising. Over the past year, rents increased at their fastest pace for more than a decade. According to property website Zoopla, UK rents were 4.6 per cent higher in September 2021 than a year before, averaging around £968 a month. Some areas in the UK still offer yields of more than 7 per cent, including Hartlepool, Middlesborough and Liverpool.

Coles says: “In the South West and the East Midlands, demand is pushing rental prices up significantly. Meanwhile, in London, rents are falling as workers leave the city and short-term lets convert to long-term lets, flooding the market with new properties.”

Estate agent Hamptons predicts that the pace of rent rises will slow in 2022 and forecasts average growth of 2.5 per cent over the next 12 months. Generally, though, property experts agree that the imbalance of supply and demand in the rental market means that the cost of rents will continue to increase.

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

There are also ways to reduce the amount of tax you incur. You can still offset 20 per cent of mortgage interest against your tax bill, although this is not as good as when higher-rate taxpayers were able to get 40 per cent relief.

Offsetting expenses against profits

Landlords can offset any expenses that are ‘wholly and exclusively’ related to letting a property. For example, these may include travel costs to rental properties and advertising costs.

“You can still offset some expenses, including water rates, council tax, gas and electricity, insuring the building, the cost of services such as gardeners and cleaners, letting agent and managing agent fees, general maintenance (but not improvements) and accountants’ fees,” says Coles.

If tenants have been unable to pay rent during lockdowns, rental income losses can be offset against your next tax bill. If you own a buy-to-let property that has remained empty for months, leaving you to cover council tax and energy bills, these additional costs can also be claimed back on tax returns.

Holding property via a limited company

Owning a buy-to-let property via a limited company has various tax advantages. All mortgage interest can be offset against tax, and companies do not pay capital gains tax (CGT) when they sell the property. Corporation tax, currently 19 per cent,is charged on profits rather than income tax. 

“If you buy through a limited company, mortgage interest can be treated as a cost that is offset against profits,” says Coles. “Tax rates can also be lower than income tax on rent. However, you’ll also be taxed on any income you take as salary and on any you take as dividends, after the annual dividend allowance [of £2,000]. You also pay more for a business mortgage and have to foot the bill for all the costs associated with running the company.”

However, Mark Harris, chief executive of mortgage broker SPF Private Clients, says: “Limited company lending is more expensive but given the growth in competition, even those specialist rates are getting cheaper. It is worth consulting a mortgage adviser who can assist in finding the best products and potentially has access to intermediary-only products.”

If you already own buy-to-let properties you’ll need to effectively sell them to the limited company and this is likely to result in a tax bill. The exact position depends on your personal situation, so if you’re interested in holding buy-to-let property via a limited company, consult a tax specialist who can advise on the implications and best strategy for your circumstances. It’s also important to note that if you have a portfolio of properties held through a limited company, you could be hit by tax rises. 

Switching to a holiday home or selling up

If a buy-to-let property doesn’t prove as lucrative as you’d hoped, you could sell it or turn it into a holiday home. Holiday lets have the potential to provide a higher income than buy-to-lets, although you have to work hard to market them and ensure bookings.

If you let a property as a furnished holiday let there are a number of tax advantages. Holiday lets are treated as a trade rather than an investment by HM Revenue & Customs, so mortgage interest costs can be offset against any income for tax purposes. Council tax, utility bills and repair costs can also be set against income, before tax. However, homes must be available to rent for at least 210 days a year and let for at least 105 a year, although cannot be let long-term. Income from holiday lets is treated as trading income so capital allowances may be available for items such as furniture, equipment and fixtures. Income received from holiday lets may also be invested in a pension and receive tax relief, unlike income from buy-to-let properties.

CGT liabilities resulting from the sale of a holiday let can be rolled over. So if you sell a holiday let and reinvest the proceeds in another, any gain on the first can be deferred until you sell the second. However, if you already own another residential property, a 3 per cent stamp duty surcharge applies when you buy a property – whether a holiday let or buy-to-let.

Whether investing in property is worthwhile going forwards depends on your personal circumstances, so you should do the calculations to establish this. Gareth Lewis, commercial director of property lender MT Finance, says: “An increasing number of property investors are looking to rejig their portfolios, possibly selling up. This will, in turn, open up new opportunities for investors to purchase property, enabling them to take advantage of current price growth and low interest rates.”

If you are selling a property, remember to offset costs such as estate agents’ and solicitor fees’ against your CGT bill. You can also include money spent on major work such as a loft conversion or extension. And you may also be able to substantially reduce your CGT bill if the property has at some time been your main residence.

Pursuing profits from bricks and mortar is harder than it used to be but may still provide an income boost, depending on your financial goals and personal circumstances. 

<box out> What about future tax rises?

There may be further changes and regulations imposed on landlords, and there have been concerns that CGT rates could increase to cover the enormous amounts of money the government has spent on dealing with the coronavirus pandemic.

The Office for Tax Simplification (OTS), for example, proposed that the annual CGT allowance – the gains you can make before having to pay this tax – be cut from £12,300 to £2,000. It also suggested that CGT rates could be aligned with income tax rates. Basic-rate taxpayers are currently charged CGT at 18 per cent for sales of investment properties or second homes, and higher-rate taxpayers 28 per cent. However Rishi Sunak recently rejected the OTS proposals and changes to CGT now appear unlikely.

Corporation tax rises from 19 per cent to 25 per cent in April 2023 for companies with profits of more than £50,000. 

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