Tax on Income from Rental Property in UK – explained

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 required to complete a tax return. Therefore the first thing you would need to do is 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 rented out your property on 1 March 2013, you would need to inform HMRC by 5 October 2013. If you do not do this you may be charged a penalty.

You should inform HMRC of your property income no matter whether you are making a profit or a loss from the property. But you pay tax only on your net rental profits – that is, your rental income, less the allowable expenses (deductions) of letting. So if you have no profit, you will have no tax to pay.

After informing HMRC they will send you a tax return to complete.

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UK property income is entered on the UK property pages of the tax return.

On your tax return you enter the income and the expenses. If your rental income is higher than your rental expenses, you are only taxed on this amount which is your profit. If your rental expenses exceed your income, you have made a loss. If this happens you should take advice as this is a complicated area.

Any profit from property is added to your other income of the tax year. If you are a basic rate taxpayer, you will 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.

Rental income

This is the total amount of rent money you receive from a tenant or a lodger (or from organisations such as the local council on their behalf) before deducting any expenses.

For example if you receive rent of £500 per month from the tenants of a property you own, the total rental income for the year would be £6,000.

Rental Expenses

You can deduct certain expenses from the total rental income. The tax you pay is based on the rental income figure after deduction of expenses. You may only deduct expenses that are the result of letting out the property. 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 not already deducted in one go.

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.

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. There are two alternative ways to work out the amount you can deduct as an expense from your rental income. One you have chosen a particular method you must stick with it. The methods are:

a) The wear and tear allowance (of 10% of rents less rates)

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) The ‘renewals basis’,

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 year you replace them.

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 like a lawnmower for use in your rental business, you may be allowed to make a deduction for the costs.

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 don’t need to keep records of your expenses and 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’ of £4,250 per year against your rental income. This means that if your lodger pays you no more than £4,250 in a year, you have no taxable rental income.

If your lodger pays you more than £4,250 then you may still use the Rent-a-Room scheme if you like, but instead of deducting the actual expenses you have made in connection with your lodger, you simply deduct £4,250 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 £4,250, so you would pay less tax using the standard rules for a property business as described in the sections on income and expenses above.

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 £4,250, 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.

Non-resident landlords scheme

The Non-resident Landlords Scheme is a way of collecting tax due on the UK rental income of non-resident landlords (those who own property in the UK, but do not live in the UK).

Moving abroad and letting out your home or another UK property?

If you are moving abroad but are going to rent out your old home, or any other UK property, it is important to realise you remain liable to UK tax on those rents and will still need to complete self assessment tax returns.

You will also need to consider if you want to register for the non resident landlords’ scheme. If you do not register, your tenant or letting agent will deduct tax from the rent you are due to get. You then claim to offset this tax against any tax owed on your self assessment return. Taxeezy can help with this registration fee of charge.

Landlord who does not live in the UK?

The non resident landlords scheme will also affect you if your landlord does not live in the UK.

  1. If you rent your property through a letting agent they will deal with this.
  2. If you live in a house owned by someone from overseas and pay rent direct to them:

If you live in a house owned by an overseas landlord and the rent is more than £100 per week, you should contact HMRC. HMRC may ask you to deduct basic rate tax (20%) from your rent before you pay it to your landlord. You would pay the tax deducted to HMRC on behalf of your landlord.

When working out how much tax to deduct, tenants and rent collectors may deduct expenses which are allowable against letting income as outlined above.

The obligations you have as a tenant of an overseas landlord, where there is no letting agent, can be quite demanding. Non-resident landlords may apply to HMRC to have the rent paid without deduction of tax. In this case HMRC will notify the letting agent or tenants that they should not deduct tax. However, the landlord is still liable to pay tax in the UK on the income they are receiving from letting their UK property. Whether or not tax has not been deducted at source (i.e. by tenants or rent collection agent), the non-resident landlord has to complete and submit UK tax returns. The process for this is exactly the same as for UK residents.

You run a property business and collect rent on behalf of overseas landlords

If you collect rent on behalf of an overseas landlord, you should contact HMRC and may be required to deduct basic rate tax from rent you collect for landlords who do not live in the UK.

Record keeping

If you receive property income, you have to keep records and keep 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.

If records are poor, it will be very difficult to challenge any claims by HM Revenue and Customs during a tax enquiry that you have not included all your income or have made deductions for non-property related expenses. Furthermore, accurate records make it much easier to actually fill out your tax return correctly and quickly.

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. This is when the property is owned in unequal shares and so income is divided in the same proportion. There is guidance on these rules on the following links.

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