Over the last few years many investors have been attracted by the buy-to-let proposition, whether their motives were to generate additional income, invest for capital appreciation or both. However, the tax implications of owning extra properties can be highly complex.

In the know

If you are a pay-as-you-earn taxpayer, you have to notify the Inland Revenue and fill in a tax return for the untaxed income you earn from the rental property. Failure to declare income in a tax return could lead to interest on late-paid tax and, potentially, fines when the Revenue discovers your omissions.

In essence, profits from a UK buy-to-let property are treated, for tax purposes, as arising from a business known as a 'rental business'. In calculating profits of a rental business, business expenses can be deducted provided they are incurred wholly and exclusively for business purposes and are not of a capital nature. Interest payable on a loan used to buy land or property which is used in a rental business is deductible from the profits of the rental business (i.e. the rental income). 

A typical situation in which tax relief would be available on mortgage interest is where a loan is taken to finance the purchase of a buy-to-let property. Interest payable on the mortgage can be set against the rental income generated by the buy-to-let property. 

Raising cash

There are no tax implications if you simply raise cash to pay off your main mortgage against equity in a second home you don't rent out. The main pitfall for second-home owners is often inheritance tax. You could consider getting your children involved and sharing the ownership with them. We can discuss this with you.

Business assets

Another point that many property investors overlook is whether owning an extra property can count as a business asset. Most people are aware of the tapering system for capital gains tax but there is a big divide between business and non-business assets. On business assets, taper relief reduces any capital gain by 75 per cent after two years of ownership, but non-business assets take ten years to get to a 40 per cent reduction in any capital gain.

Most buy-to-let property could count as a non-business asset but a furnished holiday letting, for example, could be a business asset. A holiday letting gets a few tax advantages but there are restrictions - lettings normally have to be less than 31 days each.

Also, the decision whether to run additional properties through a company or as personal assets is a very important one. You could consider your medium- to long-term goals before deciding whether or not to buy through a company or in your name.

Your home may be repossessed if you do not keep up repayments on your mortgage.

Rule changes

Potentially, there are even more complex tax challenges on the horizon with a change to the rules in April 2006 that will mean residential property can be held in a self-invested personal pension (SIPP). People who already have buy-to-lets could choose to put them in their pension. This is a chargeable event for capital gains tax as they are disposing of the property, which means it may not be worthwhile for some investors - but once it is in a SIPP, there will be no CGT when it is sold.