Income tax on a buy-to-let

premiumz

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SuperHan

You calculate the tax on the amount received less costs (but not mortgage costs), then you get to deduct 20% of the interest cost on the mortgage. There is no deduction for the capital repayment part of the mortgage. 

yksi

Here is the crux of it. Rental income is earnings. Income tax, not a capital gain or loss. Repainting, and repairing the boiler in your rental is a necessary expense in earning your income so you can deduct that cost from your earnings.

Your mortgage repayment is not allowable as an expense of earning your income because it isn't money you are kissing goodbye - you are buying something you paid for and get to keep, you are investing in the purchase of an asset. The mortgage repayment on the principal is related to the final value and the sale etc which you brought up. But you can't deal with that in the day to day running of the property as an income generator. Your principal repayment (the amount you are paying off on the mortgage's principal, or base amount) is NOT an allowable tax deduction as an expense associated with earning your income, because once you pay it off you will own the flat. You started to talk about the value of the home, and appreciation or depreciation due to the market, but capital gains tax is completely seperate and relates only to the sale and purchase of an asset. The value of the bricks and mortar, if you like. You are talking about the day-to-day earnings from it which is income taxable. 

You earn £1000 per month and spend £600 on your mortgage (that is your choice etc). Let's pretend that £50 of that payment is interest. You spend £390 on necessary expenses like maintaining the flat and fixing the boiler and paying your agent etc. From your £1000 EARNINGS you can deduct £10 for the interest allowance and you can deduct the £390 you spent on the agent, the painting and the boiler repair. You are left with a £600 income earnings which you must pay income tax on.

It all makes perfect sense when you take a broader look at it, because just imagine the taxpayer was paying you to buy yourself a nice flat... I don't think so!!!!!

Jeremy535897

You do not get taxed on the "full mortgage amount". You get taxed on the rent less expenses less 20% of the mortgage interest. You can't set a capital loss against income profits. If you had £500,000 sitting in the bank, bought the property with no loan, and got £20,000 net rent a year for a year, and sold it for £250,000, you would pay tax on the £20,000 and have a capital loss of £250,000. If you borrowed the £500,000 to buy it, and interest was 2%, you would pay tax on the £20,000 net rent, reduced by 20% of the interest (£2,000), and would have a capital loss of £250,000 when you sold it after a year.

pjcox2005

But using your example, you're effectively getting £1,000 from renting (ignoring expenses/interest) which you're then using to buy more of that property in the month. 
So if you saved up your salary and then bought the property you'd be using taxed income, but if you get rental income and bought the property you're arguing you should be exempt from it being taxed income. Effectively because someone else has paid for it (through rent - a benefit in itself), you feel you should also get the benefit of not being taxed.

Now appreciate there is a fair bit of effort in renting properly, and also tax is arbitrary in that it's just decided by Gov and doesn't actually need to have consistenty/logic. I'm just pointing out your view is a very one sided view on why a business shouldn't be taxed.  

A manufacturer for example is still subject to tax on their sales even if they reinvest the money into the business for example through buying a property.

Pennywise

You need to get back to basics and understand that income is taxed completely differently to capital gains - completely different "streams" of funds flow.  It's quite possible to pay tax on an income, but lose money on a capital gain(loss) and they can't be set against eachother.  Different rules, exemptions, reliefs and allowances for each type - rules which apply for income are different to those for capital.  You have to look at (and pay tax on) each separately.  Once you understand that fundamental difference, it all makes a lot more sense.

unholyangel

premiumz said:

Thank you for your reply.
So you need to pay income tax on the mortgage repayment?
I'm not sure if I'm missing something here but if the money was used to payback the mortgage and has not entered your personal banking account, how can they charge income tax on it?
(I'll leave out the deduction from the mortgage interest to make this example simple) Let's say a house is worth £500,000. You paid income tax on the whole £500,000 while it was being repaid. Then the property market crashes and it's now worth £250,000 but you needed the money for whatever reason and had to sell it at that value. You just spent years paying income tax on a £500,000 property being repaid and not a single penny went into your personal banking account until the sale. So you are now left with £250,000 but paid income tax on £500,000. Is that correct?
Shouldn't income tax be charged after the sale of the house if you never took a penny from it before hand. And if money was taken from the property before the sale, only that money is taxed? Like the £400 example I mentioned before.
(By the way I'm not questioning you personally as you just told me the facts)

Because the taxpayer aren't going to pay for you to acquire an asset. 

Look at it this way, you get your employer to pay your mortgage....it hasn't ever entered your bank account so how can they charge income tax on it? Because you did still receive the benefit of it, even if you don't still have it in the form of money. 

Else we'd all be deducting car payments, food bill, heating bill etc. 

premiumz said:

pjcox2005 said:

But using your example, you're effectively getting £1,000 from renting (ignoring expenses/interest) which you're then using to buy more of that property in the month. 
So if you saved up your salary and then bought the property you'd be using taxed income, but if you get rental income and bought the property you're arguing you should be exempt from it being taxed income. Effectively because someone else has paid for it (through rent - a benefit in itself), you feel you should also get the benefit of not being taxed.

Now appreciate there is a fair bit of effort in renting properly, and also tax is arbitrary in that it's just decided by Gov and doesn't actually need to have consistenty/logic. I'm just pointing out your view is a very one sided view on why a business shouldn't be taxed.  

A manufacturer for example is still subject to tax on their sales even if they reinvest the money into the business for example through buying a property.

Hello,
I was simply querying which side of the sale of the property you should get taxed on. Not whether it's the same as you spending the money or someone else to acquire the property.
In these uncertain times, I just wanted to know hypothetically if it was accurate that you would pay income tax on the property's value regardless if it tanked in the future due to the economy and you had to sell at a lower price.
In my mind, I originally thought, you would only pay income tax on any money you "skimmed" off the top each month after the mortgage had been paid, if you remortgaged and took money out, or if you sold the property. Each of these scenarios has money going into your personal bank account.
Now, this thread has helped answer my question that you will get taxed throughout the above process regardless of money going into your account.
Hope that makes a bit more sense as to where I was coming from in terms of thought process.

You're not being charged income tax on the property's value (that would be CGT, when you come to sell), you're charged income tax on the rental income. The fact you invest that rental income into the property (rather than buying food etc) is neither here nor there. 

yksi

Compare investments for a moment. You have a house to rent out and you spend £600 per month on its mortgage. You also spend the same amount, £600, each month, buying shares.

At the time the mortgage is paid off, your home has increased in value to £700,000. By the same point, your shares are also worth £700,000. These two investments sound equal now, right?

Now imagine that every time you had paid that mortgage payment, the taxpayer let you off the whole cost because you said it was a cost of renting it out. You just got a £700,000 house for free, funded by the taxpayer. You can't just pay the tax at the time to sell because what if we all lined up for our free houses, but then didn't sell? Yay free house.

This is why capital purchases are not tax-deductable from income. You certainly can't hold out your hand for £600 and say the money never went into your account because it went straight into buying shares. And you can't do it for a mortgage on a buy-to-let, either. For the same reason that I can't ask for tax relief based on the fact my salary has gone to Poundland for a box of Giant Strawbs and the money was never in my hands. The sweets are in my hands. The house is in yours.

You're probably still thinking, ouch, I paid tax on my job earnings, then my after-tax income goes into a house, then I pay tax on the rental earnings from that, and when I sell the house, even more tax in the form of CGT. I suppose you are now learning that investing in property is no longer the easy money it once was.

AnotherJoe

I hope you don't actually have a BTL because your understanding (or lack of) how it works is very scary. 

There's income tax. 
Theres capital gains Tax.
The two are different, and are charged on different things, which is why they gave them different names.
But you keep muddling them up and using them interchangeably. 

You pay income tax on the rent. You can deduct the mortgage interest, not the capital repayment. In your mortgage repayment of £600 example, any amount from £600 to almost zero could be interest.  If for example £400 was interest, you can only deduct £400 not £600 because the other £200 reduces your loan, in effect it's you saving money against your House value. It's not a cost any more than putting £200 In a building society account is a cost. 

If you bought a house for £500k and sold it for £250k you can claim a CGT loss of £250k and you'd pay no CGT on that.
If you bought a house for £250k and sold it for £500k you made a capital gain of £250k and pay CGT tax on that. 

If you do ever become a LL I suggest you use an accountant. 

premiumz

Guys, thanks for the replies. I don't need you to keep throwing analogies at me. I get it, we pay the income tax along the way and not after the mortgage is paid. Thank you for answering my question.
I've seen many guru's talk about buy-to-lets and the profits you make but not many of them talked about the income tax side of things and how it has changed over the last 3 years. I knew it was worth checking and I have now done that with this thread.

Again, thanks for the replies. Much appreciated. Thread Closed.

AnotherJoe

None of what's been discussed here is anything to do with the changes that happened a few years ago, it's always been this way, you've never been able to write the repayment part of a mortgage off, just the interest.