- Investing in Property – Some important Financial Considerations.
- Claiming all you can – the importance of good management.
- Tax allowances and tax planning considerations.
As letting property gets more competitive and the period of hyper-inflation in property prices comes to an end, managing your property investments efficiently becomes more critical.
One way you can save money and try to make sure that your property income covers your mortgage payments is to claim all the tax allowances that you are entitled to when it come to the annual chore of completing your self-assessment tax return.
Lenders will be looking for your rental income to cover around 125% of your mortgage payments, the excess being there as a safeguard to cover maintenance and replacements and void periods. Some landlords are happy with a situation where the property barely breaks ever, i.e., where their income may be insufficient to cover all the costs in the hope that property price inflation will take care of the situation long-term.
If you have a portfolio of properties you may have equity steadily building-up across the piece as happily your tenants buy your properties for you, and you may occasionally release some of this equity to re-finance and add more properties to your portfolio. Many established landlords are now developing portfolios of 5 to 10 properties and the financial institutions are realising that the average landlord represents a lower financial risk than the mainstream mortgage market, default rates among landlords being lower.
However, one should not lose site of the fact that as more and more investors enter the fray, tenants become more choosy, letting becomes more competitive, there’s a danger of saturation in some locations (particularly new builds in city centres) and there’s always the possibility of a market/economy meltdown at some point.
Therefore sensible investors will want to learn to walk before they run: they will want to build-up their experience of managing tenants and their properties properly, and they will want to build up a sensible proportion of equity in their properties and reduce their overall gearing levels (proportion of debt to equity).
Although many agents do an excellent job, and you can’t manage without them at times, especially if you live a long way from your investments, you may like to consider managing your tenants yourself long-term, saving up-to 15% of your annual rental income.
Another area for savings which can make the difference in making a profit or loss on an annual basis, is claiming your maximum tax allowances year-on-year.
First off you need to be organised. There’s nothing to stop you running a small portfolio of properties yourself and managing all the paperwork, even if you do this as a side-line to a full-time job, as many landlords do, providing you get yourself organised. You will find lots of information here on LandlordZONE™ designed to help you do just that – see the links below. One useful bit of kit is management software – see links below.
Letting property is classed as a business (Schedule A) in one sense (you can claim business expense allowances) but as an investment in another sense as some business allowances are not allowed for property taxation purposes. The good thing is receipts and expenses can aggregated from all the UK investment properties you own to produce an overall profit or loss. There are several main areas to look at here:
- You can claim tax relief on any mortgage interest you are paying to reduce the amount of income which is subject to income tax. If you have interest only mortgages these will maximise what you can claim as the interest payments do not diminish as the capital is repaid, as it would be with a repayment mortgage. This is a double edged sword: if the capital value of your properties increase steadily your mortgage amount diminishes as a proportion of the property values, but if values go the other way, well, watch out!
- Repairs and maintenance are another area to concentrate on. You can claim tax relief on all repairs and maintenance but not on improvements. Improvements will have to be capitalised, i.e. added to the capital value of the property – you only get this back when you sell, so you need to develop a good system of documenting the capital value of the property over time.
- Furniture and fittings will need to be replaced form time to time in order to keep your property competitive for letting, though claiming allowances here is covered by a special scheme. You have the choice of claiming for replacements as they occur, on accepting a straightforward year-on-year allowance of 10% of your rental income – most landlords opt for this, but you can’t chop and change.
Other things you need to claim include and agent’s management fees, professional letting fees, advertising costs, accountancy fees, insurance, void period expenses such as council tax and water rates, cleaning expenses, gardening expenses, any travel expenses to and from you properties and miscellaneous things like telephone, stationer and postage costs. You need to keep all your receipts for at least 6 years.
As property values have increased potential Capital Gains Tax and related Inheritance Tax liabilities loom large for most landlords. Some series tax planning needs to be considered by most of us in this regard as the tax allowances have not risen to anywhere near the rate at which property prices have, bringing more and more people under this insidious – some would say “stealth” tax regime.
If you sell you investment properties you could find yourself having to pay capital gains tax, and this could be a considerable amount if you purchased your properties before the boom 10 years 1995-2005. You are of course entitled to your annual tax free capital gains tax allowances (£8500 2005/6) and if you own your property jointly with your spouse that will be doubled up to £17,000. You are also allowed to deduct from the sale price, the original purchase price and buying costs, any refurbishment and improvement expenses not claimed against income tax, and any selling costs (hence the importance of keeping all receipts to each property).
You may be eligible for some taper relief on the capital gains tax depending on how long you have owned the property. If you sell the property within three years of purchase you will have to pay CGT on 100% of any gain made after the above deductions, but after that the amount you pay reduces by 5% per annum down to a maximum of 60% of the gain after 10 years
Taxation is a complex subject when it comes to planning for the future so you should consult an expert before making any decisions on these matters. Generally the further in advance you plan the more effective your tax strategy will be. For instance, depending upon the size of you portfolio and your other circumstance using a limited company or trusts can have advantages.