Property Taxes Explained: Everything Rent to Rent Landlords Need to Know

In the large UK housing market, a property business model quickly gaining popularity is 'rent to rent.' Under this model, investors lease a property from the owner and sublet the property to others at a higher rate. It is particularly attractive to investors who lack the large initial capital required to purchase property and are concerned about the long payback period to cover the initial cost.

The rent-to-rent business model emphasises control rather than ownership of the property, making it an appealing option for many aspiring property entrepreneurs. However, there are certain taxes that potential investors must understand before venturing into the journey of becoming a rent-to-rent landlord. These taxes are discussed in detail in this article, starting with the most common.

Income Tax

A key issue commonly faced by rent-to-rent investors is the classification of the income generated as property income or trading income. While the rental income is taxed at the same rate irrespective of the classification, differences do arise in claiming reliefs, using the losses, etc. Typically, when a property is rented and subsequently let out, any income is declared as property income and any expenses are claimed. However, income received from short-term lettings may count towards trading income. The losses from such trading businesses can be offset against the net income of the sole trader, unlike property business losses, which can only be offset against the property profits.   

Allowable expenses for both property and trading income are similar if incurred solely for carrying out the business, such as rent paid, repairs and maintenance, insurance, etc. Once the allowable deductions are made, the resulting profit is taxed at the following rates:

Businesses whose income is classified as ‘trading income’ may need to pay National Insurance Contributions (NIC) Class 4 if the trading profit exceeds £12,570. Sole traders can also opt to make NI class 2 contributions to strengthen their state pension.   

Stamp Duty Land Tax (SDLT)

Since the rent-to-rent business model involves investors renting out the property from a landlord and renting out to another person, SDLT generally does not apply as SDLT is only applicable to the purchase of land or buildings in the UK. However, SDLT also applies to transactions involving leases. Therefore, when an investor takes the property on lease and runs the rent-to-rent business, SDLT may come into play. 

For leases, SDLT is calculated based on both the lease premium paid and the present value (NPV) of the rent. If the lease agreement includes a premium but a nominal or minimal rent, SDLT is only calculated on the premium paid. The calculation of SDLT on lease premiums is similar to SDLT calculations for freehold purchases. However, if the lease agreement includes a premium and a high rent, it may be necessary to assess SDLT on the rent NPV as well.

The SDLT on the premium is calculated on the following rates:

In contrast, the calculation of SDLT on NPV is not so straightforward, as the NPV of the rent needs a separate calculation, which varies depending on the lease term, discount rates, etc. However, landlords typically only need to be concerned if the rent is very high. HMRC provides a calculator on their website to help determine the NPV of the rent. Once calculated, the NPV is subject to the following SDLT rates:

Value Added Tax (VAT)

When a property is rented out for long-term residential use, Value Added Tax (VAT) is not applicable. Therefore, rent-to-rent investors whose business model resonates with such lettings do not need to worry about VAT. However, VAT does apply to commercial properties and short-term lettings, typically at the standard rate of 20% on the rental price.

Certain rent-to-rent business models may qualify for VAT in the Tour Operators Margin Scheme (TOMS). Under TOMS, VAT is calculated on the margin, which is the difference between revenue and direct costs. Additionally, input tax on overheads is deducted to determine the final VAT liability. This scheme can result in significant VAT savings for businesses offering services that qualify under TOMS.

TOMS is designed for businesses that purchase 'travel services' from third parties and sell them to final customers without significant changes.

Conclusion

In summary, the rent-to-rent business model offers a unique opportunity for investors to enter the UK property market with minimal initial capital. However, understanding the tax implications is crucial for success. Rent-to-rent landlords must be familiar with the classification of income, potential SDLT liabilities, and VAT considerations to navigate the financial landscape effectively. By being well-informed, investors can maximise their profits and avoid unexpected tax liabilities.