If you’re renting out your property and you’re unsure about your tax obligations, we’ve put together some of the key facts to help you. Rules on paying tax when renting out your property can be quite complicated, and they’re updated regularly, but we’ve put together a comprehensive guide to help explain these complex rules.
Paying Income Tax
When you start letting property, you must tell HM Revenue and Customs (HMRC) as you may have to pay Income Tax. If you don’t pay, you could be charged a penalty. If you owe tax from previous years, then it’s best to contact HMRC directly. If you do, the Government website states that your case may be considered more favourably.
Any profit you make from renting out a property is part of your income, and as such, is subject to Income Tax. The amount of tax you pay on this is subject to your total taxable income. If you pay the basic rate of tax then you’ll pay 20%, while if you’re a higher rate taxpayer, you’ll pay 40%, and if you’re in the additional rate bracket you’ll pay 45%.
It’s also worth noting that if you live in Scotland, you may pay a different rate of Income Tax to the rest of the UK.
If you’re eligible, you may also be able to claim Income Tax reliefs, which means that you either pay less tax to account for the money you’ve spent on specific items or get your tax repaid. Sometimes you get these tax reliefs automatically, but there are others you must apply for to be eligible.
In order to calculate your costs, it may be worthwhile setting up a separate account for your rental income. This will stop your various revenue streams from becoming confused, and it may also be easier for you to work out your profit, expenses and other forms of income.
It’s vitally important to remember that only profits from renting your property are liable for income tax and that to calculate your profits, you’ll have to deduct ‘allowable expenses’ first.
Calculating ‘allowable expenses’
As you calculate your expenses, you need to know the difference between revenue and capital expenses.
Revenue: revenue expenses relate to the day-to-day running and maintenance of the property and can be offset against an income tax bill.
Capital expenses: expenses that’ll increase the value of the property, such as renovations. These can’t be deducted from your income tax bill, but you may be able to offset them against Capital Gains Tax.
Any costs that are deemed to be essential to you performing your duties as a landlord can be offset against your rental income, significantly reducing your tax liability. Allowable expenses are things you need to spend money on as part of the day to day running of the property, including:
- any letting agents’ fees
- legal fees for a year or less, or for renewing a lease for less than 50 years
- accountants’ fees
- buildings and contents insurance
- interest on any property loans you may have taken out
- money spent on maintenance and repairs (but not home improvements)
- utility bills
- rent, ground rent and service charges
- council tax bills
- any services you pay for, such as cleaning and gardening
- any other direct costs incurred, such as phone calls, advertising or stationery
Things that you can’t claim as allowable expenses include:
- the full amount of your mortgage payment - only the interest element of your mortgage payment can be offset against your income (more on this later)
- private telephone calls - you can only claim for the cost of calls relating to letting property
- personal expenses - you can’t claim for any expense that wasn’t incurred solely for your rental business
If you’re a landlord who’s letting a furnished property, then you can also claim 10% of the net rent as what’s known as a ‘wear and tear allowance’. This can be used on any furnishings that you provide to your tenants. For this, the net rent is the amount of rent that you receive, less any costs that your tenant would usually pay - such as council tax.
However, in the 2015 Summer Budget, the Chancellor of the Exchequer, George Osborne announced a slight change to the legislation on ‘allowable expenses’. In the past, landlords were able to deduct 10% of the rent charged for ‘acceptable wear and tear’, even if no actual improvements had been made.
However, as of April 2016, landlords have only been able to deduct expenses they actually incur.
Landlord tax relief changes
Also in the Summer 2015 Budget, George Osborne announced that tax relief for buy-to-let landlords would be restricted in order to “create a more level playing field between those buying a home to let and those buying a home to live in”.
As a result of these changes, the amount of tax landlords can reclaim as relief was capped at the basic rate of tax (20%) over the course of a four-year period.
This is the case regardless of whether the landlord’s paying the lower or upper rate of tax, meaning that the amount of tax relief that landlords in the top tax brackets receive on their mortgage interest payments will be slashed.
Relief for finance costs was restricted to the basic rate of Income Tax from 6 April 2017. These financing costs include mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans.
As a result, landlords will no longer be able to deduct all of their costs to arrive at their property profits. Instead, they’ll receive a basic rate reduction from their Income Tax liability. The scheme will be introduced gradually, meaning that:
- in 2017-2018, the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs. The remaining 25% is available as basic rate tax reduction
- in 2018-2019, this will change to 50% finance costs deduction and 50% given as a basic tax reduction
- in 2019-2020, this will change again to 25% finance costs deduction and 75% given as a basic rate tax deduction
- from 2020-2021, all financing costs incurred by a landlord will be given as a basic rate tax deduction
The gradual introduction of the changes over four years should theoretically help landlords adjust. If you need a little extra help, we’ve got some advice on how to prepare for the changes as well as some guidance on ways you can minimise the impact of the new system.
If your letting activity is deemed as 'running a property business', you may also be required to pay Class 2 National Insurance Tax.
You'll be considered to be running a property business if being a landlord is your primary job, you let more than one property or you acquire properties with the intention of renting them out.
You'll need to pay this tax if your profits are over £5,965 a year. If they’re under this figure, you can make voluntary National Insurance payments which, for instance, contribute towards you being entitled to the full state pension.
Stamp Duty Land Tax
As of April 1 2016, anyone purchasing a second home or buy-to-let investment has been required to pay an additional 3% in Stamp Duty Land Tax.
The rates for additional properties are as follows:
Therefore, if you purchase a buy-to-let property for £375,000, the stamp duty bill will be a total of £20,000, compared to £8,750 under the old system. This stamp duty calculator is very useful for working out how much the additional 3% will cost you.
Capital Gains Tax
Landlords will also be required to pay Capital Gains Tax (CGT) when they sell a property that’s increased in value.
CGT’s only payable on properties that aren’t the owner's main residence. Working out the gain you've made on the property is pretty straight-forward, you need to deduct the price you bought the property for from the total you’re selling it for. You’re able to deduct costs such as agents' or solicitors' fees and the costs of improvement works.
Once you've worked out your gain, you can find out how much CGT you may need to pay by using a calculator like this.
There’s also an abundance of Government guidance on the complex terms and conditions of CGT, which you can find here.
Calculating your profits
If you’re looking to work out your net profit for your lettings as a single business, then you must:
- add together all of your rental income from all of your properties
- add together all of your allowable expenses
- take away the expenses from the income
If you’re making a loss
If you’re making a loss on your rental properties then you’ll need to deduct any losses from profits and enter the figure on your Self-Assessment form, remembering that your losses can be offset against future profits (by carrying it over to a later year) or against profits from other properties in your property portfolio.
Completing your tax return
Tip: If you complete your Self-Assessment tax returns online, you get an extra three months to submit.
The deadlines for online and paper tax returns are listed here, where you can also find further information about the current tax year.
The site also provides helpful guidance regarding how you complete your tax return. It’s very important your tax return is completed accurately and within the relevant time-frames, otherwise you can face penalties. The details of the nature and severity of such penalties can be found on the charity Tax Aid’s website.
A final piece of advice is to speak with other experienced landlords, letting agents or an accountant about the taxation rules surrounding rental properties. Their knowledge in this area can be an invaluable source of information to help make sure you’re following best practices.
Disclaimer: The content of this page was last updated on 23rd March 2017. Whilst we’ve prepared the information within this page with care and have made every attempt to ensure that the information at the time of publication is accurate, this information shouldn’t be relied upon as a substitute for formal advice. The information contained in this document is for general information purposes only, we reserve the right to edit, discontinue or withdraw this, or any other report. Any use of this content for an individual’s own commercial purposes is done entirely at the risk of the person making such use and solely the responsibility of the person or persons making such reliance.
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