Large Tax Bill - Is it worth being a landlord?

[thebigpenguin]

Hello,

First post so hello all. I am looking for some guidance to see if I am doing something daft. We have a property that is rented out, the proceeds of which my wife and I split on our tax returns. We are both higher rate tax payers. We have a repayment mortgage on the property. I was just modelling the tax payable for us both. To add some colour the property makes about £18k in rent and the mortgage is about £13k and about £4k of that is interest. So we declare the rent income of about £8k each less some repairs and the interest portion of the mortgage. The issue I have is by the time we pay a combined tax bill of £5k the property is really operating at a loss. I know the HMRC has reduced the way it treats loans down to basic rate tax (so basic rate tax relief on the interest portion of our mortgage) I am starting to wonder if it makes any sense to keep property if you have a job in the higher tax bracket. Am I missing something or have I misunderstood the way the tax works?

thank you for any advice

[AGoodman]

No, that's it.

If you are making a loss on the income vs interest, you're gambling that you'll make a bigger capital gain.

[someone]

Hello,

the property makes about £18k in rent and the mortgage is about £13k and about £4k of that is interest. So we declare the rent income of about £8k each less some repairs and the interest portion of the mortgage. The issue I have is by the time we pay a combined tax bill of £5k the property is really operating at a loss.

It's not really operating at a loss (ignoring house price changes), you're paying off about 9k of the mortgage each year so your net assets will increase by that amount.

For example (per person):
Asset less mortgage at start of year: (100k asset, 50k mortgage) 50k
cash: 0
Total assets in business: 50k


Taxable income 7k
mortgage interest 2k
Tax on income 2.8k
mortgage interest tax relief 0.4k
capital repayments 4.5k

Asset less mortgage at end of year 54.5k (assume no price change, 100k asset, 45.5k mortgage)
Cash at end of year year: 7k-2k-2.8k+0.4k-4.5k = -1.9k
Total assets in business at end of year: 52.6

So you've made about 2.5k on an investment of 50k in this example, so a 5% return. But you've had to put money into the business to generate that, i.e. the business is cashflow negative, generating 4.5k of asset growth but needing 2k of cash injected to do that.

You might, of course have a lot less invested - in which case the return looks a lot better - or a lot more invested. I guessed a mortgage rate of about 5% and a 50% LTV.


One thing to think about is that once the mortgage is paid down the business should be cashflow positive. This can mean property is a nice way to use debt now to fund a pension later. I can't do the calculation in my head but I'd guess with these numbers you'd have the mortgage paid off in about 8 years and it would take another 3 years to repay the cash you've added to the business in the interim. (Do the calcs and then tell me how bad my guesses are )

The numbers look better when only one person in the couple is a higher rate taxpayer as income can be shifted to the lower rate taxpayer but, of course, a couple with only one higher rate taxpayer isn't managing to take full advantage of the basic rate band of one of them. But maybe by the time you actually need an income from the property you'll be basic rate taxpayers.

[thebigpenguin]

Hello,

Yes I see what you mean. Its a £500k house with a £170k mortgage. Each year we our investment goes up by about 5% in value.

[nomisbaffled]

I'm sorry to jump onto this post with another question as fist time poster, would be grateful if anyone could confirm my calculations are correct and whether it is worthwhile for us to continue with our plan.

Married, UK residents (England) and HR taxpayers - we're looking to turn our main home into a BTL once we've found our next house to live in.

Using the below theoretical values which assume to remain constant throughout the mortgage deal, and PA/AE have all been utilised:
Property valuation £625k
BTL interest only mortgage of £356,250.
5y fixed BTL rate of 6.14%; annual interest payment of £21,874.
Annual rental income of net of expenses, but before interest deduction, of £25,300.
Amount liable to income tax £47,174 (£25,300 + £21,874) @ 40% = £18,870 tax due before mortgage interest relief.
Final tax bill £14,495 (£18,870 - 20% £21,874).
Net cash outflow/loss £11,069 (£25,300 - £21,874 - £14,495).

Therefore, our BTL asset will need to increase by £15,373 or 2.46% to break even every year - is this correct? (£11,069/(100-28))/625k.

Many thanks.

[Lambs]

N,

Your calculations make some sense but do keep in mind that as the property has apparently been your "main home" so presumably your only/main residence for CGT purposes, it will usually enjoy at least some exemption for that proportion of your period of ownership. These work on a "total period of ownership" basis so your CGT value uplift in Yr1 of letting will not be 'purely' @ 28%. If you intend to keep the property until you both die, then IHT is the issue, not CGT.

Regards,

Lambs

[someone]

Annual rental income of net of expenses, but before interest deduction, of £25,300.
Amount liable to income tax £47,174 (£25,300 + £21,874) @ 40% = £18,870 tax due before mortgage interest relief.

Perhaps I'm missing something but that looks wrong.

If your net income is 25300, then your tax is 10120, not 18870. The mortgage interest is an expense, not an income, but it doesn't reduce your tax bill.

You have another expense of 21874 to pay the mortgage interest which gives you relief of 4375, so the net tax bill is 5745.

So:
receipt 25300, less tax is (roughly) 20000 which means you're around 2K short on the rent paying the mortgage interest.

So you need a capital gain of around 2K per year to break even, not 14K

[Lambs]

I concur with S' point: you cannot add back something you have not yet deducted. So, if the interest has not yet been deducted then it shouldn't be disallowed (again).

Regards, and thanks to Someone,

Lambs

[nomisbaffled]

Ah, you're right S, I've deducted the MI when I shouldn't have as it's not included in the rental income in the first place! Thank you for pointing that out - the revised calculations now look better.

Your point on IHT/CGT is noted L, thank you.