Buy to Let Tax Relief and Allowances

What you need to know about tax on your rental income.. allowable expenses you can claim and completing a tax return…

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If you’re a landlord it is important that you understand what tax you are liable for. Our guide tells you everything you need to know about the rules for income and capital gains tax when you let a property.

Tax on Rental Property

Self Assessment – Tax Returns for Landlords 

People who receive rent or income from land and property in the UK are normally required to complete a tax return and you need to inform HMRC that you are receiving property income by 5 October following the end of the tax year in which you received the income. The UK tax year runs from 6 April to 5 April the following year. Therefore, if you first rented out your property in the 2018/19 tax year, you would need to inform HMRC by 5 October 2019. If you do not do this you may be charged a penalty.

If you are non-resident in the UK, tax should be deducted at source by the letting agent (or tenant), who should be made aware of your residence circumstances. This normally bypasses the need for a tax return concerning the property income, however, can be very tax inefficient if you are entitled to UK personal allowance, being that this won’t be taken into account. Also, you may have other expenses not accounted for in the calculation of profit from which the agent deducts tax at basic rate and pays it over to HMRC. Filing a tax return will resolve this and often results in a reclaim of overpaid tax. The method of application and associated registration is different for non-residents and Taxeezy can advise you on this aspect free of charge. See the more detailed notes below.

Generally, you should inform HMRC as soon as possible, via the applicable method, regardless of whether you are making a profit or a loss on the property . You pay tax only on your net rental profits – that is, your rental income, less the allowable expenses (deductions) of letting. So, in it’s simplest form, if you have no profit, you will have no tax to pay.

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The UK Tax Return Property Pages.

If your rental income is higher than your rental expenses, you are only taxed on this amount, subject to the availability of UK personal allowance. If personal allowance is available, this will offset the tax calculation to the extent of the available amount and, particularly for non-residents, can result in no tax liability at all, even with fairly substantial profits. If your rental expenses exceed your income, you have made a loss which can be carried forward to offset future profit. Losses made in prior years can be accumulated and carried forward, however, must be used against first available profit.

Any profit from property is added to your other income of the tax year. If you are a basic rate taxpayer, you will currently pay 20% income tax on your rental profits. National Insurance is not paid on rental profits. The tax due is collected under self-assessment – usually a tax bill due by 31 January each year or, in some circumstances, via your tax code.

Rental Income

This is the total amount of rent money you receive (or your agent receives) in a tax year from a tenant or a lodger before deducting any expenses.

For example if the tenant pays £500 per month for the whole tax year, the total rental income to be entered on the tax return is £6,000.

Rental Expenses

You can deduct certain expenses from the total rental income. The tax calculation is based on the rental income figure after deduction of expenses. You may only deduct expenses that are incurred wholly and exclusively in the course of the letting business. There are special rules for some types of expenses – especially property repair costs.

The sort of expenses that you can deduct from the rent that you get are:

  • Ground rent you have to pay
  • Letting Agents fees
  • Legal fees on renewing short leases (but not when they are first made)
  • Interest on a loan or mortgage obtained for the purchase of the property (see notes below)
  • Mortgage arrangement fees charged by the lender (see notes below)
  • Other interest directly related to the business may be allowed
  • Cost of gas safety certificates or similar requirements
  • Insurance
  • Accountant’s fees
  • Repairs and maintenance (see notes below)
  • Telephone calls
  • Travelling expenses
  • Wear and tear allowance if the property is furnished. (see notes below)
  • Use of Home as Office (see notes below)
  • Advertising for tenants
  • Repairs and maintenance to the property (see notes below)

If you have several properties, all rental receipts and expenses can be lumped together, so expenses on one property can be deducted from receipts on another.

Notes regarding expenses

Mortgage Interest

The main property expense for most people is the mortgage payment. You can deduct only the interest part of the mortgage payment. If you have a repayment mortgage, the repayment part of any payments is not an allowable deduction. This means that the mortgage interest may be less than the full monthly repayment you make, as your mortgage repayments may include repayment of capital.

If you remortgage the property to withdraw equity or secure the loan on a different property you may still be able to get relief for the interest but you should seek further advice as this is a complicated area.

Mortgage arrangement fees charged by lender

You can deduct mortgage application fees on an annual basis over life of the mortgage loan for Income Tax purposes and it does not seem to matter if you paid the fee out of cash in one go instead of adding them to the loan.

In other words, no matter whether or not you add the fee onto the mortgage loan or pay it out of cash, you should still deduct over the course of the loan. So if the fee was £2,500 and the loan was over 25 years, that’s £100 per year you can deduct.

If you go on to clear the mortgage early – say because you sold the property or because you remortgaged it, then you can deduct the outstanding fee.

So, in this example, if you remortgaged after 5 years, (say because you found a better mortgage deal), as you would have only used up £500 (i.e. £100 a year for 5 years), the remaining £2,000 of the £2,500 fee could be claimed in one lump as a valid deduction in the tax year you remortgaged.

Changes to relief for Interest and Finance Costs

From the 2017/18 tax year onwards, interest and finance costs are being restricted to basic rate relief. The transition is occurring over four tax years, at 25% per year, until fully restricted. Thus, in the 2021/22 tax year these costs will be fully restricted. Accordingly, if you are a higher rate taxpayer, you will be affected as the restricted amount is not used in the calculation of profit (i.e. not used as an expense). The restricted amount is carried down in the calculation to purely relieve tax at basic rate and, if the full amount is not required in relief, it can be carried forward to the following tax year.

The treatment of Repairs and Improvements

Ongoing repairs to the fabric and structure of a let property are expenses which can be deducted from your rental income. Examples of such repairs include:

  • exterior and interior painting and decorating,
  • damp and rot treatment,
  • mending broken windows, doors, furniture and machines such as cookers or lifts,
  • re-pointing
  • replacing roof slates, flashing and gutters.

But you cannot deduct expenditure on improvements, or expenditure needed to bring a property up to standard before the first letting. Expenditure on improvements can be added to the costs of the property and may reduce any capital gain when you sell the property.

The dividing line between improvement and repair can be difficult to judge. For example, if the windows needed replacing in the property you own, but you replaced single glazed windows with double glazed windows, is this a repair or an improvement, or a bit of each? In cases like this, you will be allowed the normal ‘modern equivalent’ – so double glazing is accepted as a ‘repair’ and you can deduct all the costs against your rental income.

Where there is a significant element of improvement – such as you replace the kitchen, then at least some of the expenditure is likely to be treated as improvement, as so you cannot deduct this from your rental income.

Furnishings

If you are letting a furnished property, and it has sufficient furnishings for the tenant to be able to live there without providing anything more, you are allowed a deduction for the cost of the furnishings and equipment. The methods are:

a) Wear and Tear Allowance (2015/16 and prior tax returns):

This is an amount you are allowed to deduct each year to cover the cost of the equipment and furnishings. Rather than work out exactly what you have spent, you simply deduct a ‘round sum’ each year. The ‘round sum’ is calculated as 10% of your total rental income, less any charges and services that would normally be borne by a tenant but are, in fact, paid by you as the landlord (for example council tax, water and sewerage rates etc) . For example, if the annual rent was £6,000, and you did not need to pay the council tax, water and sewerage rates etc, then the annual wear and tear allowance would be taken as a £600 deduction each year.

b) Domestic Items Allowance (2016/17 tax returns onwards):

Using this method, you are not allowed to deduct anything you spend on equipment and furnishings when you first let the property. But you may deduct the costs of any replacement item in full in the tax year that you replace them. The replacements apply to furniture, furnishings or kitchenware and must be ‘like for like’ and not an improvement in facility.

For example, you spend £700 on a bed when you first let your property out. You are not allowed to deduct any of this cost from your rental income. After 6 years, you replace the bed, getting nothing for the old one, and spend £950. You may deduct the whole £950 in the year you replace the bed.

If you need a vehicle or equipment, such as a lawnmower, for use exclusively in your rental business, you may be allowed to make a deduction for the costs by way of ‘capital allowance’.

Rent-a-Room

If the property income you have is from lodgers, there is a special scheme you may choose to use. It is called the Rent-a-Room scheme. To qualify you must have one or more lodgers living in your home. By a lodger, HMRC means someone who is living with you as a member of your household, but paying you to do so.

If your ‘lodger’ has a separate front door, kitchen and other facilities, then this would not qualify for the Rent-a-Room scheme.

Under the Rent-a-room scheme you may not need to fill in tax returns – this is the case if you don’t normally receive a tax return and your receipts are below the tax-free thresholds for the scheme. The tax exemption is automatic so you don’t need to do anything. But if your receipts are above the threshold, or you do not want to use the scheme, you must do a return and accordingly register. Taxeezy can help you with this free of charge.

You are given a flat ‘deduction’ per year against your rental income. This means that if your lodger pays you no more than the available threshold in the tax year, you have no taxable rental income.

If your lodger pays you above the threshold, then you may still use the Rent-a-Room scheme, however, instead of deducting the actual expenses you have incurred in connection with your lodger, you simply deduct the amount of the threshold from your income. If you have high costs, such as a large mortgage, you may find that the actual expenses which relate to the lodger – including a proportion of your mortgage interest – are more than the threshold, so you would pay less tax using the standard rules for a property business as described in the sections on income and expenses above. In this way, you can combine rent a room income and expenses with the letting of other properties.

Rent-a-Room for a small B & B

If you run a B&B, you would normally be treated as trading. This would mean that you would need to register as self-employed, pay class 2 National Insurance and send in annual tax returns. But if you run a B&B from home on a small scale, you may use the Rent-a-Room scheme. This means that if your B&B income is under the threshold, you would be treated as not having made any profit at all. One possible disadvantage here is that if your expenses are more than your income, you would not be able to claim tax relief for any business losses if you use Rent-a-Room.

If you use the Rent-a-Room scheme for income from a B&B then you would include income for meals as well as the room rent.

Record Keeping

If you receive property income, you have to keep records and store them for 6 years. A simple single entry cash book or simple computer spreadsheet or accounting system is enough. But it must be kept up to date. You will need to keep all the necessary paperwork to back up your cash book or computerised records. It is sensible to have a hard copy of essential information in case your computerised records are damaged or lost. This includes bills you pay and copies of the rent receipts/invoice you send to your tenant. If you use a letting agent make sure you keep all the statements and other documents that they send you.

Jointly Held Property

There are special tax rules for jointly owned property for married couples and civil partners. The rules mean that you can’t simply decide between yourselves how you want to be taxed or, for example, just give the rental income to the member of the couple with the lower income. The tax rules say that income from jointly owned property must be split and taxed in equal shares. Only in exceptional circumstances can a different split be used, such as when the property is owned in unequal shares and income (profit) is accordingly divided in the same proportion. Also, there are legal agreements that can be made concerning a different split of income, which then have to be ratified by HMRC.

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