Sunday Times Article by Clare Francis - June 2007

THOUSANDS of landlords are being urged to contact Revenue & Customs as it prepares to target buy-to-let investors who have failed to pay the right amount of tax.

As the Sunday Times Money section revealed Revenue officials have been furtively collecting information on landlords using a new computer system that trawls letting ads. They have also set up a whistleblowing hotline, which has received thousands of tip-offs from other property investors.
Tax inspectors have now identified an estimated 80,000 landlords who have either claimed too much tax relief on their rental income, or who have failed to declare that income. They are now considering sending out leaflets to buy-to-let investors to make sure they understand the rules.
However, landlords who think they have got it wrong are being urged to act now: under the Revenue’s tax amnesty, people who declare mistakes before June 22 pay lower penalties of up to 10% of the tax owed, compared with up to 100% usually.

Chas Roy-Chowdhury, head of taxation at the Association of Chartered Certified Accountants, was at a recent Revenue workshop to discuss property investors. He said: “I think the Revenue is trying the lightweight approach first to encourage those who have simply made a mistake with their tax return to come forward. But it has a lot of information about landlords, so anyone deliberately evading tax who fails to act could face a full-scale investigation further down the line.”

Buy-to-let has become hugely popular in recent years as many investors have looked to capitalise on booming property prices. There were just under 850,000 outstanding buy-to-let mortgages at the end of last year, according to the Council of Mortgage Lenders, up from 73,000 in 1999.
Landlords are a potentially lucrative source of tax for the Treasury: they face a capital-gains tax bill up more than £4 billion when they sell, according to Landlord Mortgages, a buy-to-let broker.
But while the Revenue said most landlords are believed to be accurately completing their tax returns, thousands are not – ranging from “those who have made simple mistakes to those who wilfully under declare their earnings,” it said.

We explain the rules.

I am a buy-to-let investor, what tax should I be paying?
Income tax is payable on any rental income you receive. This must be declared on a self-assessment form. There are a number of allowable expenses that can be deducted from your income to reduce your tax bill. If these exceed your rental income, there will be nothing to pay.
What can I offset against the rental income? You get tax relief on any mortgage interest you pay. In other words, if you have rental income of £850 a month but your interest repayments are £500, you would be liable for tax on only £350 (assuming you make no other deductions).
Does it make a difference what type of mortgage I have? Yes. The tax relief applies only to interest, not capital repayments. In order to maximise the tax relief, it is therefore advisable to go for an interest-only rather than repayment loan.

As the name suggests, monthly payments on an interest-only mortgage cover only the interest. With a repayment loan, your monthly payments go towards paying off some of the capital, too, so the amount of interest you accrue reduces year on year and the tax relief you get also declines.
Melanie Bien at Savills Private Finance, a mortgage broker, said: “Most landlords opt for an interest-only mortgage because it enables them to keep their mortgage payments to a minimum while maximising the tax relief they get from being able to offset their rental income.
“There is no reason why you can’t go for a repayment loan because the interest element is still tax-deductible, but the tax relief reduces every year and the calculation is more complicated.”

What else can I deduct from my income?
Landlords can also offset things such as letting agents’ and accountancy fees; buildings and contents insurance premiums; and the cost of services you provide for the tenant, such as cleaning or gardening.
You cannot offset structural improvements to the property, but you can deduct the cost of replacement furniture, white goods and furnishings. This can either be done by keeping receipts, or claiming 10% of the annual rental income as wear and tear. The latter tends to work out to be better value and it is also simpler than documenting individual replacements.
You need to keep details of all income and expenditure for up to six years in case the Revenue queries anything on your tax return.

I don’t think I’ve paid enough tax. What should I do?
If you believe you owe the Revenue money, contact it as soon as possible – it will look on you much more favourably than if it has to come after you. You need to contact your local inquiry centre. You can find the nearest one on the Revenue’s website, hmrc.gov.uk.
If you take advantage of the tax amnesty before June 22, you will have to pay what you owe before November 26 plus a reduced penalty of up to 10%.
Property investors who don’t take advantage of the amnesty, however, could face penalties of up to 100% depending on the severity of the case.
Someone who had made a genuine error would probably escape the fine, but if tax officials judge that you have deliberately avoided tax, they will come down much harder.

What if I have paid too much tax?
Contact your tax office. You will either be asked to write a letter explaining what you think is wrong, or complete a revised tax return. You will get a refund plus interest and you can claim back any tax you have overpaid in the past six years.

What is likely to happen to the buy-to-let market?
Interest rates have risen four times since August and surveyors say that many landlords are struggling to cover their mortgage bills with their rents, with an increasing number choosing to sell up.
The latest lettings survey from the Royal Institution of Chartered Surveyors found that the number of investors selling their property at the end of their tenant’s lease jumped from 4.1% in the final quarter of 2006 to 5.2% in the first three months of this year.
Jeremy Leaf at Rics said: “Rising borrowing costs and a drop in yields have contributed to a worrying time for landlords. Interest-rate rises later in the year will havea further dampening effect.”

Should I sell?
With house-price growth still relatively strong, surveyors expect more landlords who have been in the market for a while to jump ship to realise their capital gains.
However, analysts believe the buy-to-let market still offers good opportunities – if you have your eyes open. You should be prepared to cover any shortfall in income from your savings, and should not expect capital growth to be as strong as it has been in the past.
Tim Hague at Birmingham Midshires, one of the country’s largest buy-to-let lenders, said: “There is still great demand for rental property. This is coming from the increasing number of first-time buyers who are priced out of the market, high immigration levels and changing employment patterns. Also, there is a shortage of stock.”

Will I have to pay tax if I sell my buy-to-let property?
Yes. There may be a capital-gains tax liability when you come to sell. The first £9,200 of any capital gain is exempt from CGT, but you have to pay it at your marginal tax rate on any profit above that amount.

Can I cut my CGT bill?
Yes. If you are married, it is worth transferring half the property into your spouse’s name before the sale so you can make use of both your CGT allowances. This means that £18,400 of the gain will be tax-free.
If you have owned the property for more than three years you will also qualify for non-business-asset taper relief. If you sell within three years you pay tax on 100% of the gain, but this reduces by 5% a year thereafter, down to 60% after 10 years.
Say you sell a property that is jointly owned after 10 years for a profit of £100,000. Once taper relief is applied, you are liable for tax on only £60,000. You then deduct both CGT allowances, taking the tax liability down to £41,600. Assuming both owners are higher-rate taxpayers, the bill would be £16,640.
Mike Warburton at accountant Grant Thornton said: “Things are even better if you are renting a home you previously lived in.”
You would not be liable for tax for the years you lived there, and for the last three years of ownership. You can also claim lettings relief, worth £40,000 per owner. So if you sell a property after seven years, having lived in it for three, CGT will only be payable on one year’s profits. The lettings relief, plus taper relief and your CGT allowances, would probably wipe out your liability completely.

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