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Why a stocks and shares ISA beats buy-to-let every time

Should I invest in buy-to-let property or stocks and shares? It’s one of the oldest questions in investing. And I often hear strong views from people on both sides of this debate.

It probably won’t surprise you to learn that here at the Motley Fool, we believe the stock market is a much better home for your cash than a rental property.

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There are several reasons for this, as I’ll explain.

Don’t pay tax

Let’s start with a quick reminder. A Stocks and Shares ISA allows you to invest up to £20,000 each year, completely free of tax. You won’t pay any tax on income and capital gains received within the ISA, ever. And you can withdraw cash from the ISA without facing any additional tax bills.

In contrast, buy-to-let investors pay an extra 3% stamp duty (in England) and are subject to both income tax and capital gains tax. Indeed, recent changes mean that many landlords are now facing rising income tax bills.

These factors can make a big difference to your income and wealth.

For example, a dividend income of £20,000 per year received in an ISA would be tax-free.

But for a basic rate tax payer with no other income, buy-to-let income of £20k could result in a £1,500 income tax bill. For higher-rate tax payers who also have an employment income, the tax bill could be much higher.

Spread your risk

If you invest in buy-to-let, then your rental property will probably be your main investment. Many investors plan to use property as the main source of funds for their retirement.

The risk here is that you have all your eggs in one basket. What if future tax changes make buy-to-let less profitable? The value of your property might fall. Mortgage costs could rise. Selling a house is costly and slow.

By investing in the stock market, you can spread your exposure across a range of businesses, sectors or even different countries. Any problems will hopefully be restricted to one part of your portfolio, and won’t affect all of it. And if you need cash, you can usually sell instantly.

It’s cheaper

Anyone who owns a house knows that maintaining a property isn’t cheap. Even if you do most jobs yourself, the costs add up. Insurance, maintenance, boiler repairs and decorating. The list can seem endless.

If you’re renting out a property, you’ll have to meet all of these costs yourself. Tenants will rightly expect a professional service, so putting jobs on the back-burner for months won’t be good enough.

You’ll also have to comply with a range of safety standards that don’t apply to your own home, and you may have to pay agency fees.

In contrast, a stocks and shares ISA is a very cheap investment. The ISA account I use costs about £100 per year in fees, including most of my share-dealing costs. That means I get to keep more of the profits from my investments.

Can I invest in rental property on the stock market?

The UK stock market is home to a wide range of property stocks, including several that specialise in owning residential rental property.

If you want to invest in rental property, I firmly believe a Stocks and Shares ISA is the best way to do it.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.