As a landlord, you’re liable for income tax when you rent out a property. Calculating what you owe is often far from straightforward, so we’ve put together a handy guide to help you understand how it all works.
When you rent out a property you personally own, you must pay tax on any profit you make. Your profit, known as property income, is your rental income minus any expenses or allowances you can claim.
Property income is then added to your other income and the total determines your tax band and the amount of tax paid. You may also be able to claim a basic tax rate reduction on your finance costs.
Once everything is calculated, it’s all reported to HMRC via your self-assessment. The calculation itself can be a little complex, so we have broken it down into sections to help you through.
The rules are different if:
You rent out a room in your home you live in
The property is a furnished holiday letting
The property isn’t in the UK
You rent out a UK property whilst living abroad
Lava Sky Accounting can manage your property finances as well as complete and submit your self-assessment so that all your property income tax obligations are taken care of. Book a free consultation today.
Ownership
If the property is jointly owned, then the rental profit or losses are split based on the share of the property you own – unless there is an agreement in place with different allocations. If you own the property with your spouse or civil partner, then the profit or losses will be split in equal shares – again, unless you have declared beneficial interest stating otherwise.
Accounting methods and record-keeping
From April 2017 the default accounting method for individual and partnership landlords with an income of £150,000 or less for the tax year is using cash basis. This means that transactions should be accounted for when money has actually been received or spent.
By contrast, when using the accrual basis – the traditional accounting method – transactions are recorded when money is due or owed, irrespective of whether the money has actually been received or paid.
You can opt to use this latter method even if you meet the criteria for cash basis. However, you must use the same method for all properties you rent out.
A record of all rents received, and expenses incurred, must be kept for at least 6 years after the end of the related tax year.
Rental Income
Rental income refers to any monies you receive from your tenants, which can cover not just the rent but any additional services you provide such as paying for utilities or cleaning.
When a property is managed by lettings agents, property management fees are often deducted before transferring the remaining money to the landlord. Rental income is the gross amount – the amount the tenants have paid not the amount the landlord receives from the letting agents. These property management fees should be claimed as an expense, which we will cover later in this article.
Allowable Expenses
Expenses that are wholly and exclusively for the purposes of renting out the property can be deducted from your rental income to calculate you profit or loss. Any expenses that are for personal purposes are not allowed.
Expenses must be revenue in nature rather than capital, meaning they will be for the day-to-day running of the property such as utility bills and not for the purchase or enhancement of the property.
Examples of allowable expenses are:
Lettings agent fees
Professional fees associated with the letting
Building, contents and landlord insurance
Maintenance and repairs
Utility bills
Ground rent and service charges
Council tax
Services related to rental such as cleaning and gardening
Other direct costs such as advertising
Repairs are an allowable expense and normally deductible. For example: painting and decorating; mending broken windows and doors; replacing broken or missing roof tiles.
However, improving or upgrading classes as capital expenditure – adding value to an asset – so isn’t allowable for calculating rental profit or loss. The exception is where the work is a natural upgrade to a modern equivalent, for example if you replaced single-glazed windows with double glazing.
Any professional fees relating to a capital matter cannot be expensed – for example, the legal fees in relation to the asset’s purchase or architect’s fees for an extension. Capital expenditure may qualify for capital allowances and are processed through capital gains tax.
Finance costs
Finance costs are interest and costs incurred in the borrowing of money. For landlords, the most common finance cost is a mortgage on the property being rented out.
Previously, a landlord was able to claim 100% of the mortgage interest occurred as an allowable expense. However, from April 2017 the government introduced a phasing out of this and by 20/21 only a basic rate reduction will be given. For landlords who are basic rate taxpayers, this will not make a fundamental difference.
For the 20/21 tax year and onwards, only a basic tax reduction can be claimed. In the unlikely scenario that allowable expenses outweigh income, the tax reduction cannot result in a tax refund.
The tax rate reduction is the basic rate (which is currently 20%), which is applied to the lowest of the following:
Finance costs – this will be the mortgage interest for the tax year
Property business profits – the profits from the property business for the tax year
Adjusted total income – individual income (after losses and reliefs, and excluding savings and dividends income) that exceeds your personal allowance
For example:
George only has residential income for the 20/21 tax year. Here are his key figures:
Finance cost from mortgage £4,000
Property profits £30,000 (£36,000 income minus £6,000 allowable expenses)
Adjusted total income £17,500 (£30,000 minus personal allowance of £12,500)
As his tax relief is 20% of (20/21 basic rate) and his finance cost is the lowest of the above figures, George is able to claim tax relief of £800 (20%*£4,000).
Replacement of domestic items relief
For properties that are let furnished or part-furnished, inevitable expenses will be incurred in order for you to maintain these items. Replacement of domestic items relief allows a deduction for the cost of replacing domestic items. It was introduced in April 2016 and replaces the previous wear and tear allowance.
As a landlord, you can claim the cost of replacing the domestic items, however you cannot claim against the initial expense. So, while the expense of the first fridge you purchased for a property can’t be claimed, you can claim for a replacement if the first one breaks down.
Only a like for like basis can be claimed – if the replacement item is an upgrade then the claim is limited to the equivalent replacement value. The exception is when a modern equivalent replaces an older one such as a fridge with an improved energy efficient rating.
If you sell the old item, this will reduce the relief. On the other hand, if it costs you to dispose of the item then this can be added to the claim.
Domestic items include:
Moveable furniture e.g. beds, sofas
Furnishings e.g. curtains, lampshades
Household appliances e.g. fridges, cookers
Kitchenware e.g. cutlery, utensils
Qualifying pre-commencement expenses
A rental business starts when the first letting commences. Expenditure incurred prior to the letting of the property is treated as if it was incurred on the day on which the letting business commences. This is the case provided the expenditure is wholly and exclusively for the letting business, is within 7 years of the letting business start date and it would have been allowed if the expense was incurred after the rental business had started.
Small rental income – property allowance
In April 2017 the property allowance was introduced. A taxpayer who earns less than £1,000 from property in a given tax year is exempt from tax on this amount and doesn’t need to complete a self-assessment tax return.
If property income is more than £1,000 then the landlord could choose to claim the property allowance instead of their expenses. This will only be beneficial if your allowable expenses are less than £1,000.
If you’re a landlord looking for help with your finances, Lava Sky Accounting offers self-assessment services so we can fill, submit and calculate your tax for you. We can also manage the day-to-day bookkeeping of your property business so you can concentrate on running your business. Book a free consultation today.