A Buy-to-Let property is the dream for many. Property ownership, combined with solid income every month – your ticket to financial freedom?

Here’s the thing – having a BTL is a lot sexier than some shares tucked away online somewhere. The Brits love bricks-and-mortar. And the “gurus” who sell property courses will make you think it’s a no-brainer.

I’m not here to tell you whether you should or shouldn’t go for it. I’m just a tax accountant who can’t even put up a shelf let alone manage a property. There’s obviously loads of non-tax things to think about, which I’ll leave to the experts. 

But, based on nearly a decade of seeing the “back end” of property ownership – through dealing with dozens of BTL investors – I thought it would be useful to make some comparisons between BTL and boring old fashioned “bung it in an ISA”, in terms of what you’re left with after HMRC take their cut.

I’m obliged to say “this isn’t investment advice, speak to a financial advisor etc etc”… but I am pleased to say this IS tax advice – which is useful, as it’s what we do!

Why does the government hate landlords?

I don’t know. But they do. So, generally, profits on BTL are at a higher rate than any other type of income in the UK. Which means you really need a high yield to make it worth it.

Consider my client John (name not changed because, well, it’s John). He lives in Taunton so these figures might be different in your neck of the woods.

John earns about £60K and has a BTL property. He paid £190K for it, with a £150K  mortgage and a £40K deposit. He also paid Stamp Duty of £5,700, and solicitors fees of £3,000. 

With mortgage arrangement fees – always higher with BTLs – and other bits, the purchase set him about about £200K.

He was aiming for a yield of 5%, or about £850 per month. He managed to let the property through an agent for £1,000 per month, which gives him a yield of 6% on the cost of buying the property. John is a happy man!

That’s £12 large in the bag per year. 🤑

But of course, it’s not free money. John’s costs – for simplicity – include:

– Agent commission 10% = £1,200
– Gas/electric checks = £200
– Insurance and repairs = £500
– Our accountancy fees, which John is delighted to pay, are £360.
– The mortgage interest. The mortgage is interest-only, fixed at 5.00%. So that’s £7,500 per year in interest.

Punch in the numbers and that’s total expenses of just under £9,800. So John’s left with £2,200 (£12K – £9.8K) for the year.

As a higher-rate taxpayer, he’s naturally expecting to pay tax at 40%, leaving him with a profit after tax of £1,320. 

But HMRC have other ideas…

The Mortgage Tax Trap!

But the thing nobody ever asks us before they go house hunting is that, for higher-rate taxpayers, you only get relief for HALF of your mortgage interest.

The calculations behind the scenes are a bit more involved than this (before any other accountants start filling my DMs!) but broadly HMRC will take John’s £2,200 profit and add back half the interest before taxing him.

So that’s £2,200 plus [£7,500 @ 50%] = £5,950 of taxable profits. John will pay tax of 40% on £5,950, which comes to £2,380. 😱

The eagle-eyed among you will have spotted that £2,380 is MORE than £2,200.

In other words, John’s marginal rate of tax is 108%. He’s paying more in tax than he’s making from the property!

The more your interest is, the worse off you’ll be. If John were able to re-mortgage to a lower rate after his fixed term – lets say he gets it down to 3.5% – then he’ll make a profit before tax of £4,500. Much better.

But HMRC will take £2,800 from him, leaving him with just £1,700. 

So, at least it’s a profit, but it’s a long way from the yields John thought he would get. An effective tax rate of 62% is pretty eye-watering.

Can I avoid this happening to me?

Perhaps. If you’re set on purchasing a BTL then consider some options:

Firstly, this only applies to rental income which is mortgaged. So if you aren’t paying any mortgage interest, there’s nothing to worry about. Which is fine, but John didn’t have £200 big ones sitting about.

Secondly, if you’re a basic-rate taxpayer, you *might* avoid this tax trap. Although with the way the numbers work, if you earn £40K-something then you might still be caught. So for example, if John’s spouse was a lower earner (she’s not) then he might consider gifting the property to her.

Or, thirdly, some advice you’ll hear around the place is “oh, just put it in a Limited Company”. This might be a good idea, or it might not – waaaaay outside the scope of this blog, so give me a call if you’re pondering it and I’ll see how it applies to you personally. The numbers are a bit more complex.

OK, point taken…is there a better way?

I’m glad you asked. Let’s look at what John could have done instead of getting into property.

John’s put £50K of his own money into this venture (deposit + buying costs). Even with his shiny new 3.5% mortgage rate, John’s left with a profit after tax of just £1,700.

Let’s say instead he put it in a stocks and shares ISA instead. The limit is £20K a year so this would need to go in over 3 tax years – the limit resets on 6th April each year. Or, only two years if Mrs John didn’t already have her own ISA.

A low-risk ISA (at time of writing) is going to return you about 5.3%pa. Once John’s got £50K into his ISA, this is going to generate him £2,650 before tax.

Doesn’t look as sexy as the £4,500 figure from the BTL above, does it?

But here’s the silver bullet – £4,500 rental profit before tax becomes £1,700 after tax. ISA income is entirely tax free. So that £2,650 before tax is…well…£2,650 after tax as well. 🙌

Thanks, but I deffo want to do a BTL!

That’s great. For people who know what they are doing, find property with potential and – usually – have a much better idea than me on how to do their own repairs/renovations/management etc, it can be a profitable venture.

But to avoid (potentially) putting £200K+ into a venture which ends up returning you almost nothing after tax, PLEASE book a call with your accountant so they can run some numbers for you before it’s too late.

And, naturally, if you don’t have an accountant then, er, hello 🙋‍♂️. Hit the CONTACT button in the bottom right to pop a call in my diary. I’m happy to talk through the basics with you, no charge. 

If you’d like some detailed figures off the back of that – and to look at whether a property company would be a better or worse option – the cost is just a couple of hundred pounds. 

Think of it as an insurance policy before you make the (second?) biggest purchase of your life. 🏠