Understanding my taxes as a landlord
As a landlord you need to pay income tax on rent you receive from your properties. Here we explain how income tax is applied to rental income and how you can report this on your income tax return.
What counts as rental income and how do I work it out?
There are three types of rental income:
- Investment property (We cover this here)
- Holiday accommodation (furnished holiday lettings or FHL) or trading income
- Renting a room in your house
Your rental income is not just the rent you receive from tenants. This also includes any fees they may pay for other services such as utility bills, cleaning communal areas, and arranging repairs.
Any non-refundable deposits are also included as part of your rental income, as well as any parts of refundable deposits that are not returned to the tenant.
What expenses and allowances can I claim?
Expenses you can claim relate to the running of your property rental business and also any maintenance costs need to upkeep your property. Note that any capital expenditure, such as extensions, will be deductible when you come to sell the property.
Allowable deductible expenses that landlords may usually have include:
- Letting agent and property management fees
- General maintenance and repairs
- Landlord insurance
- Utility bills and Council Tax
- Service costs such as cleaning wages
- Admin costs (includes costs incurred when running the business or searching for tenants such as office equipment, mobile phone, stationary and advertising fees)
- Accounting fees
With Taxd, you can ensure that the maximum allowable expenses are claimed in your Self Assessment tax return. This ensures that you pay tax only on the profit that you should be paying tax out of.
Tax on income from multiple properties
If you have more than one property then you can offset the income from one against the loss of the other. The properties are essentially pooled together as one investment, combining the income and losses to reach an overall profit or loss.
Overseas properties and shares of a rental business are not included in the above.
How much tax will I pay?
Property is taxed using income rates.
Let’s say that, for example, your salary is £45,000 per year and your rental taxable profit is £8,000. Therefore, your total taxable income is now £53,000.
Based on the current rates you will not pay tax on your first £12,570 earned as it is your Personal Allowance. You will then pay the basic rate of 20% from £12,571 to £50,270. And the remaining £2,730 will be taxed at the higher rate of 40%.
Buy-to-let tax relief for 2020/2021 onwards
From the 2020/2021 tax year landlords can no longer deduct mortgage interest from income. Instead, they can deduct a fixed amount equal to 20% of the mortgage interest as a tax credit.
For example, if your mortgage interest is £500 a month, you will receive £100 as a credit.
Real life scenario
Let’s have a look at how this works for different taxpayers based on a rental property that brings in £1,000 per calendar month (pcm).
If your salary together with your rental income exceeds the Personal Allowance (up to £12,570) but stays within the basic rate band (from £12,571 to £50,270), then you will pay tax at 20% on earnings above the Personal Allowance.
So, £1,000 pcm is £12,000 annual income. It is taxed at 20%, so that’s £2,400. But you receive £100 from the mortgage interest each month, which is £1,200 for the year. So your final tax bill is £1,200.
Before the rules changed in April 2017, you could deduct the mortgage interest in full. So a £12,000 annual income minus £6,000 mortgage interest leaves £6,000 taxed at 20%, which is £1,200.
You can see here that if your income stays within the 20% band then you have not been affected by the buy-to-let tax relief changes and the tax paid is the same.
If your salary exceeds the basic rate band and your rental income falls into the higher rate band of 40% (currently between £50,270 and £150,000), then you will pay additional tax compared to before April 2020.
For example, with an income of £12,000 (in higher rate) your tax would be £4,800. Once the tax credit of £1,200 is applied to the mortgage interest, your overall tax bill is £3,600.
Before the rules changed, deducting full mortgage interest your tax bill would have been £12,000 minus £6,000 at 40%, equalling £2,400. So, you can see that the new rules mean you have an extra £1,200 tax bill.
A key point to note is that some landlords now will be pushed into the higher rate band of 40% without realising, since the amount of income they have to report is higher. The tax is on the overall rental income — that is, the £12,000 in the above example — whereas before you could deduct the £6,000 mortgage interest first leaving you with £6,000 (net) income.
Let’s say you have a salary of £44,000. The old rules meant that your total income would have been £50,000 (£44,000 salary plus £6,000 in net rental income). But now your earnings are £56,000 and therefore £6,000 of the income has fallen into the 40% band and will be taxed as the above.
How do I prevent myself from paying this extra tax in future?
Spouse or partner
The first thing prospective landlords or landlords looking to expand their portfolio should do is make sure they are utilising the Personal Allowance or the 20% band of their spouse or partner.
With rental income, you only pay tax on your share of the property. So, if you jointly own a property with your spouse and have a £12,000 rental income, this will be split in half and only £6,000 will be taxable on your return.
So, if your spouse or partner is not working or earns less than you (under the higher rate band of 40%) then it would be wise to either buy the property in their name or split the ownership.
If your spouse or partner does not have any other sources of income then rental profit of £12,570 or less will be tax-free. If they, for example, earn £30,000 then they have another £20,270 within the basic rate band of 20% to use.
This is a very simple and effective way of reducing your tax bill. Unfortunately, it can be complicated to transfer existing property to family members and we would recommend getting in touch with a solicitor if this is something you would like advice on.
Another option many landlords are now using, is purchasing property through a limited company. This has become more common since the mortgage relief changes, as within a company you can expense the full mortgage interest cost.
Tax on profit is also at the corporation tax rate which currently stands at 19%. This means that more of the property income is kept. This is particularly good for high income earners who otherwise would have to pay 40% to 45% tax and get less relief on the mortgage interest.
If your goal is to hold the property for many years and reinvest the income, then a company may work as it will lead to faster growth (due to more earnings being retained). However, it is important to remember that the property income belongs to the company.
So if you wanted to take this out for personal use you would need to extract it via salary or dividends which will be taxed at the personal income tax rates. Similarly, if you were to sell the property, any gain would be in the company, and a similar approach would be needed to extract the funds.
Therefore, knowing when you will exit is extremely important when purchasing property. Income tax savings in the short term may lead to a larger cost later on. Alternatively, if you know you will be paying a higher tax for years to come, it could be much more advantageous in terms of growing a portfolio.
When will I pay this tax?
Profits and taxes due are calculated across a UK tax year. That is, from 6th April of the current year to the 5th April of the following year, each year. Once the tax year ends, the earnings are reported via a Self Assessment return. This can be done from the day after the end of the tax year. But remember, the 31st January following the end of the tax year is your deadline.
You always report the income as per the tax year it relates to in your tax return, even if you receive the money after.
For example, your tenant paid for the rent for March on 10th April. While this payment was made in the new tax year (on or after 6th April), it relates to March of the previous tax year and so that income needs to be reported as part of March earnings.
This is similar to expenses. Any expenses you have can be deducted for the year the work was actually completed. Whether you pay the bill before or after the tax year does not matter.
How does this look on a tax return?
HMRC have introduced thresholds when it comes to declaring rental property. You need to complete a tax return if your total property income is £10,000 or more before expenses and if it is greater than £2,500 after deducting expenses.
If it is less than £2,500 then contact HMRC as you may be able to have your tax collected outside of the Self Assessment.
If you need to complete a Self Assessment then you will also need to complete the additional UK property pages (for investment rental property).
Declaring losses on rental income
If across the tax year you have made a loss on a property or multiple properties then you can carry this forward to offset future profits.
Unfortunately, this cannot be offset against tax you have paid on other income, such as your employment.
For example, in the 2020/2021 tax year you had £12,000 in rental income, but had to spend £15,000 on expenses. Here you can record a loss of £3,000. Now if in 2021/2022 after deducting expenses your profit was £3,000 (or less) you can offset the loss against this and not pay any tax.
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