Landlords: beware false profits

Many buy-to-let landlords put the profitability of their investments in jeopardy by failing to plan for taxes right at the start. Decisions on the price-band of the property, the type of mortgage, even the choice between furnished and unfurnished letting can all lead to very unpleasant bills from the taxman later. So the first step for the would-be investor is to get expert advice.

"Paying tax is a fact of life. However, the amount of tax you pay can be reduced if you understand and take advantage of the tax breaks available to you," says Lee Grandin, the managing director of the specialist buy-to-let broker Landlord Mortgages. "We strongly suggest that all buy-to-let investors review their portfolio and speak to an expert about tax mitigation techniques. The cost of several hours of an expert's time is considerably less than the tax bill you could receive."

An investor must bite the bullet and pay for advice rather than rely on free opinions from a personal finance advisor or (worst of all) a mortgage salesman.

One tax that is paid up front is stamp duty, and this can be minimised by buying in areas that qualify for Disadvantaged Area Stamp Duty Exemption, says Grandin. Landlords looking for properties in a certain area may well save several thousand pounds simply by buying a property just over the border in the designated ward - a list is available at www.hmrc.gov.uk/so/disadvantaged.htm. Properties must be worth less than £150,000 to qualify.

Couples who invest have several options to minimise their tax bill, Grandin points out. The property can be jointly owned, so both partners' capital-gains-tax allowances can be used when it is sold.

"If your spouse is in a lower income-tax bracket than you are it may be a good idea to transfer the buy-to-let property into their name in order to minimise the amount of tax you pay," Grandin says. "But you must trust them!"

Grandin also strongly advises filling in your tax return honestly and accurately. "The Inland Revenue investigates over 10,000 returns each year," he points out. "If you are one of the unlucky few and have not filled in your returns accurately, you could end up with a substantial tax bill, a fine or even a prison sentence."

Accountant Carl Bayley has produced a valuable guide to the tax issues facing buy-to-let investors, titled How to Avoid Property Tax, available from www.taxcafe.co.uk either as an electronic download (£20) or in print (£25). He advises a period living in your investment to minimise capital gains tax.

"The very top tip would be if at all possible not to buy-to-let but let-to-buy," he says. "Let out your existing home and move into your new property, as this can make huge capital gains savings."

Another key decision is the type of mortgage to take out. "You can claim mortgage interest against earnings, so it may be worthwhile taking out an interest-only mortgage," Bayley says. "Also, investors often fail to appreciate that you can secure the loan against your own house but still put the interest against the earnings on the buy-to-let property."

If the flat is let furnished, you can claim for the depreciation of the furniture and fittings in various ways, but the decision has to be made in advance.

"If it is a furnished let you get a wear-and-tear allowance of ten per cent of the gross rent, or you can claim replacements, but you have to make an either/or decision on all your properties in advance," he explains. "I find the wear and tear option is best unless you are letting in a market where you can expect very high levels such as, dare I say it, students."

Companies have many tax advantages as a way of holding a property portfolio, but limited companies must be a long-term option only, "because of the capital gains tax payable when the company is wound up," Bayley says.