A guide to property development tax

Whether you’re considering property development as an investment opportunity or have grand plans for a property development empire, you’ll need to factor in the impact business taxes could have on your profits.

In this quick guide, we’ll explain the different taxes that impact buy-to-let and buy-to-sell property investment. We’ll look at mortgage tax relief, the extra stamp duty that you’ll pay on investment property, and how the taxman differentiates between property investment and property trading.

We’ll also touch on whether you should form a limited company to invest in property, and generally tell you everything you need to know to avoid a hefty tax bill ruining your property development dreams.

This guide will cover:

What is property development tax?

Let’s get one thing out of the way first – there’s no such thing as a ‘property development tax’. Which taxes will affect your property development investments depends on your chosen strategy – most notably, whether you want to buy an extra property that you then rent out (buy-to-let), or you plan to buy a property, do it up, and then sell it (buy-to-sell).

Here are the taxes most likely to affect you, and a brief idea of what activities they apply to:

• Stamp duty – This one is pretty much inescapable. If you buy an additional property – in other words, one that isn’t your main home – then you’ll pay extra tax.
• Income tax – If you receive buy-to-let income as an individual, you’ll need to declare that income and pay income tax on it.
• Corporation tax – If you receive buy-to-let income as a company, you’ll need to declare that income and pay corporation tax on it.
• Capital gains tax – If you sell your property for a profit, then you’ll need to pay capital gains tax (CGT) on the proceeds.

(Various reliefs, exclusions, and limits apply to these taxes – these are discussed in the relevant sections below.)

Bearing this setup in mind, you might be tempted to form a limited company for your property investment activities. After all, corporation tax is significantly lower than income tax, and you’d then pay the corporation tax rate on your buy-to-let income instead of income tax.

However, the real picture is much more complicated:

Now, let’s get stuck into the nitty gritty, starting with stamp duty.

Stamp duty

You probably already know what stamp duty is, or Stamp Duty Land Tax to give it its proper name. If not, the Money Advice Service has a great breakdown – it’s the tax you pay when you buy a property in England and Northern Ireland.

What you need to know as a property developer, though, is that stamp duty is higher on any additional residential property – with an extra 3% charged on top of the normal bands.

The price at which you pay tax is also much lower, starting at £40,000 (as opposed to £125,000 for standard house purchases).

Here’s what this means in practice. You’ll pay:

• 3% tax on the first £125,000
• 5% on the portion up to £250,000
• 8% on the portion up to £925,000
• 13% on the portion up to £1.5 million
• 15% on everything above that

(If you’re buying a property in Scotland or Wales, then different rates apply. In Scotland, you’ll pay Land and Buildings Transaction Tax, while in Wales, it’s Land Transaction Tax.)

If you’re confused by that “on the portion up to” stuff, it essentially means that different parts of your purchase are charged at different rates. You’ll need to do a bit of maths to work out what you’ll actually pay.

Let’s say, for example, that you buy an additional property worth £500,000:

As stated above, you’ll pay 3% tax on the first £125,000.

To work out 3% of £125,000, the easiest thing to do is multiply £125,000 by 0.03

£125,000 x 0.03 = £3,750

Next, you’ll pay 5% on the amount between £125,000 and £250,000 (the next threshold)

£250,000 – £125,000 = £125,000

So, you’ll pay 5% on this £125,000 – to work this out, multiply £125,000 by 0.05

£125,000 x 0.05 = £6,250

Finally, you’ll pay 8% on the amount between £250,000 and £500,000 (the next threshold is at £925,000, so in this example, you’re now just calculating up to the purchase price)

£500,000 – £250,000 = £250,000

To work out 8% of £250,000, multiply £250,000 by 0.08

£250,000 x 0.08 = £20,000

Your total tax bill is therefore the sum of these three figures:

£3,750 + £6,250 + £20,000 = £30,000

So, on a £500,000 additional property purchase, you’d pay £30,000 in stamp duty.

If you want to work out your actual stamp duty rate, divide this figure by the purchase price, then multiply by 100.

In this case:

£30,000 divided by £500,000 = 0.06

0.06 x 100 = 6

In other words, the actual stamp duty rate on a £500,000 additional property purchase is 6%

Income tax

You probably won’t be too surprised to learn that, if you receive regular income from a buy-to-let property (i.e. rent payments), you’ll need to declare and pay tax on that income.

The amount of tax you pay will depend on what tax band you fall into.

As of 2019/2020, these bands are:

• 0% on anything up to £12,500
• Basic rate: (annual pre-tax income of £12,501 to £50,000) – 20%
• Higher rate: (annual pre-tax income of £50,001 to £150,000) – 40%
• Additional rate: (annual pre-tax income of over £150,000) – 45%

Need help managing your accounts?

As a property developer, tax will be just one of many financial factors you’ll need to keep on top of. Whether you develop properties to sell on, rent out, or live in, you’ll have to understand your outgoing costs and incoming revenue. From paying for materials and paying staff wages to calculating any tax you owe on rent, there’s a lot to bear in mind.

You can get external help from accountants to help you stay on top of all of these things, but we recommend using accounting tools to save yourself time and money. In the past, accounting was a long, tedious and manual process; with modern software, it has become far easier.

Check out the list below to find the accounting tools we recommend.

Mortgage interest tax relief

Once upon a time (before April 2017), you were able to claim a hefty tax relief for mortgage interest, as you could deduct your mortgage interest from your rental income before working out your tax liability.

However, that system has now been phased out, in favour of a 20% reduction in the amount of tax you pay (rather than the amount you pay tax on). This also applies to higher and additional rate taxpayers, so no matter how much tax you pay, you’ll only be able to claim a 20% reduction.

Analysis from mortgage broker L&C indicates that a basic-rate taxpayer should expect to pay the same amount of tax under both systems, while a higher-rate taxpayer would face a significantly larger bill under the new system.

However, these changes may have an impact beyond these calculations – an increase in taxable income could affect entitlement for Child Benefit and Income Tax Credits, for example.

Allowable expenses

The other legal way to reduce your income tax bill is by factoring in what are called “allowable expenses”. This is a list of things that the government considers to be related to the management and ownership of your property, and that are therefore not liable for tax.

Aside from mortgage interest (which is discussed in detail above), the main ones include:

• Council tax, insurance, and ground rent payments
• Property maintenance (this does not include substantial improvements, such as extensions; these may however reduce how much capital gains tax you pay if you come to sell the property)
• Letting agency fees or property management fees
• Fees associated with advertising for new tenants

(This is not a comprehensive list – for more details, check the official government page on income tax and property letting.)

Corporation tax

Compared to the complexities of stamp duty or the multiple bands of income tax, corporation tax is mercifully straightforward.

The basic corporation tax rate for company profits is 19%.

The complications come when you’re trying to work out how to reduce your corporation tax bill.

The basic idea is that you can take the cost of business expenses away from your profits, and then reduce the amount of profit that you pay tax on.

In practice, there are limits on what you can and can’t claim for. The most important guideline is that you can claim for expenses that have been genuinely needed by your business, and that have been exclusively used by your business.

There are also different restrictions according to what type of property company you are operating (see the investment vs trading section for more details). If you’re not sure about a particular expense, talk to your accountant, or contact HMRC directly.

With those caveats in mind, here’s an idea of what you might be able to claim as a legitimate business expense:

• Company salaries
• Travel and parking costs
• Office supplies
• Business insurance
• Company mobile phone contracts
• Business calls on your home phone
• Home office expenses
• Advertising/marketing
• Professional fees, such as those paid to accountants and solicitors

With any expenses, make sure you keep your receipts, as HMRC may want to see these as evidence of your spending.

Capital gains tax

The simplest way to understand capital gains tax (CGT) is that it is a tax on individual profits. It is generally applied to one-off gains on investment (such as selling shares), but different rates are applied to sales of property.

(It’s worth noting here that you won’t pay CGT if you sell your home, as this is not considered an investment for tax purposes.)

Everyone has a CGT tax-free allowance of £12,000, so if your profit is below this amount, you don’t need to report it and won’t pay tax on it.

Once you go above this level, your CGT tax rate will depend on your income tax band:

• Basic rate income tax payers (those with an annual pre-tax income of £12,501 to £50,000) will pay 18% CGT on property sales
• Higher or additional rate taxpayers (those with an annual pre-tax income over £50,000) will pay 28% CGT on property sales

There may also be costs you can deduct from your taxable profit. For property, the principal examples are:

• Fees paid to solicitors/estate agents
• Substantial improvement works, such as building an extension

Final thoughts

While this guide should give you a basic overview, property development tax is a complex area, and we would recommend consulting the services of an accountant who has experience dealing with property before making any significant decisions.

Similarly, carefully research any tax area that affects you to get a good idea of what would be best for your individual circumstances, and always research whether you might be able to use reliefs or allowable expenses to reduce your tax bill.