If you’re a higher rate tax payer you’re currently liable to pay 40% tax on any profits you currently make on your rental properties. So assuming your Buy to Let business is making a profit each year then you really have two options to minimize your tax bill:
- Remortgage such that your mortgage interest payments are equal to your rent less expenses. (Beware with this option as the rules around tax relief on mortgage interest are changing soon – see below)
- Accept you’ll have to pay tax on your profits and seek to maximize tax breaks elsewhere that can potentially offset this liability
Over the last few years as I have deleveraged my portfolio of properties I have employed the second option above. The simple, and quite elegant solution to me is to…
Reinvest all BTL profits into additional personal pension contributions.
Ok, so the title of this post might have been a little misleading, I’ve not found some magic way of avoiding the tax, merely just achieved the mental equilibrium that I’m directing the taxable income to another investment vehicle that provides an offsetting tax benefit.
Higher rate tax payers currently receive 40% tax relief on pension contributions which will perfectly offset the tax due on your BTL profits. In tax paid terms I’m flat. At the same time I’ve got an ever increasing equity stake in the rental properties (thanks to the capital repayments being made each month) and an ever increasing pension pot.
Of course tax relief on pension contributions aren’t all received up front. A higher rate tax payer will receive 20% relief on their contribution. In cash flow terms this means their pension provider will add 20% to the contribution (and claim it back form the government). This means your £1k contribution immediately becomes £1.25k in your pension.
The remaining 20% needs to be claimed back via your self assessment form. This means that all other things being equal, HMRC will write you a cheque for £250 at the end of the tax year. Any cheques I receive from HMRC tend to get sent to the mortgage company to reduce my outstanding capital or invested elsewhere.
Of course I’m sure there will be people that read this and feel aggrieved at a buy to let landlord (who is also a higher rate tax payer) benefitting from further tax breaks. Well in my defense I’m only playing the game the government puts in front of me. However, those that have been baying for Buy To Let blood will have been exceedingly pleased by the chancellors announcement in the last budget to restrict the tax relief on buy to let mortgage interest to the basic rate of 20%.
I’ll cover these changes in a separate post. Thankfully my BTL strategy has been a low risk one so the forthcoming changes to mortgage interest tax relief won’t have a huge impact on me.