Taxes are among the highest costs of any investment, and savvy investors will want to be as tax-efficient as possible when making their decisions. There are ways to minimise the tax burden for property investors and ensure an investment generates strong returns. Some good reasons exist for considering tax-efficiency measures because investors lose the money they pay in taxes, and this ‘loss’ hampers an investment’s growth potential.
Tax efficiency – especially in the UK real estate market – is vital. While some investors look to purchase a single property, others wish to invest in a portfolio of both residential and commercial properties. For these investors, understanding the various taxes involved and how to manage them will ensure they can enjoy the benefits of property ownership for the long-term.
Paul Smith, Touchstone Education co-founder, is an experienced property developer who has helped investors learn tax efficiency through the organisation’s property courses. In a scenario where an investor has a combination of residential (buy-to-lets) and commercial (shops) investments, the experts at Touchstone Education offer various strategies to consider, including the use of limited companies and pension schemes. Through these, the Touchstone Education team hopes that investors can manage their tax burden while growing their portfolios.
The Taxes Levied
The various taxes that investors can expect to incur while owning, managing, selling or buying property include:
- Capital Gains Tax: Capital Gains Tax (CGT) is levied when selling property. Investors who sell their main home in the UK may not pay CGT, but those who sell additional properties are likely to incur this tax.
- Rental Income Tax: The profits made on rental income are treated like an individual’s income, and are therefore subject to income tax at normal rates.
- Stamp Duty Land Tax: Stamp Duty Land Tax (SDLT) is levied on property purchases in England, and different tax rates apply depending on an asset’s value.
Investing Through Pensions
Pensions are attractive tax-efficiency strategies because they are free from capital gains and investment income taxes. Additionally, tax relief is offered when individuals contribute to a pension, which is levied on contributions at the highest income tax rate. This relief can be as much as 40 percent for high-rate taxpayers, while additional rate taxpayers can receive as much as 45 percent.
Pension contributions that reach the annual allowance of £40,000 (or 100 percent of income if lower) can be made with tax relief at the individual’s income tax rate. The pension pot structure allows these contributions to remain tax-free, and they can be invested in allowable assets to generate more tax-free income. The top pension options that investors consider are Small Self-Administered Schemes (SSASs) and Self-Invested Personal Pensions (SIPPs). Designed for business owners, they allow investment into a wide variety of assets.
Investing Through Limited Companies
Property investment through a limited company has grown popular among investors, particularly with changes to the tax relief offered to buy-to-let landlords. This is because the taxes levied and relief offered to incorporated businesses differs from those provided to individual owners. Investors in a limited company act as the directors and shareholders, which allows the entity to offset mortgage interest costs directly against realised income. Additionally, the corporation tax rate is lower than the personal income tax rate.
With the savings gained from this reduced tax exposure, a limited company can consider investing further in its property portfolio. However, there is a drawback to pursuing this avenue, as access to funds is restricted. As such, this option is more viable for investors who don’t want to access their revenue in the short term.