Efficient Rental Income Tax – The Ultimate Guide
As a landlord you will need to pay tax on the property or properties you rent out.
Hopefully, this will be a quick and easy guide that will simplify how rental income is taxed.
As a landlord you are normally asked to pay income tax on any profit you make from renting out a property. This is the whole rental income less any expenses or allowances. Expenses can be maintenance, insurance, letting agent fees, council tax, water, gas, electricity, gardener, cleaner, legal fees, accountants’ fees etc. You can also claim for any rents, ground rents, service charges and for any direct costs, such as advertising for new tenants, phone calls, stationery etc.
You can no longer claim Mortgage interest as an expense but can claim 20% of the mortgage interest as a tax credit which is explained in a little more detail later on.
You can also claim for wear and tear on properties that are fully furnished but the Government only allows you to claim tax relief on monies spent replacing what it classes as ‘domestic items’, i.e., beds, sofas, carpets, curtains, crockery, cutlery or for white goods [fridges, freezers, cookers, microwaves] etc. Replacement must be like for like! You are also able to claim back the cost of disposing of items such as white goods.
Can rental expenses be offset?
So as an example, a landlord charges £1,000 a month rent, inclusive of bills, they would need to calculate the whole amount as income (though some of the costs could be charged as expenses). The rental income is £12,000 per annum.
If at the end of a tenancy the Landlord keeps the deposit of £1,000 to cover repairs on the property, then this amount will be added to the £12,000 income meaning you would have to declare £13,000 as your rental income. However, you would then be able to deduct the £1,000 spent on repairs on the property as an expense.
Basically, your rental profits are taxed at the same rates as the income you would receive from any sole trader business. 0%, 20%, 40%, 45%, depending on which tax bracket the income falls into.
You must bear in mind that if you are employed or receive other income through work, the figures reported on your Self-Assessment tax return would be your employment income/self-employed income, plus any rental income which could send you into a higher tax bracket!
Let’s say you earn £40 000 pa and you have a rental income of £13 000 a year. Your total income will be £53,000 per annum. The threshold for higher tax payers for 22/23 is set at £50,270, which means the Landlord would have to pay 40% on the £2,730 which is above the threshold.
If you are renting out several properties, all rental receipts and expenses can be calculated and added together. So, expenses from one of your properties can be deducted from receipts from another.
This however only applies for rental properties in the UK. Any overseas properties, i.e., a Spanish Villa, expenses against this property cannot be added to expenses against UK properties. There is a separate section in your tax return for declaring profits from overseas properties.
You can receive £7,500 a year from a lodger before you need to pay tax!
If your lodger pays you less than £7,500 a year, you will be automatically exempt from paying tax on this income and will not have to complete a tax return. The only thing you need to do is keep a record of the income. However, you cannot claim expenses on the rent a room scheme.
To qualify for the rent a room scheme you must offer fully furnished accommodation within your own home. You don’t need to own the property to qualify but, if you rent the property and then sublet, you will need the Landlord’s permission. If you are letting out part of your house and your house has a mortgage, you will need to get the mortgage providers permission. In both the above cases you will need to get the appropriate home insurance.
Since April 2017, the way Landlords declare their income started to change! The changes were incremented on a sliding scale down to what is today. On the old scheme you could deduct your mortgage interest as an expense, but as from 2020 this is no longer the case.
From April 2021/22 you can no longer deduct any of your mortgage expenses from your rental income. To reduce your tax bill today, you will receive a tax credit based on 20% of your mortgage interest. This means that Landlords that fall into the higher tax bracket are really going to feel it!
If you have a rental income of £10,000 per annum, and you have a mortgage where you are paying £9,000 a year interest, you now have to pay tax on the whole £10,000, which if you are in the 20% tax bracket will be £2,000. However, you will then get a 20% tax relief on the £9,000, which amounts to £1,800. Deduct the £1,800 from the £2,000 and you have a tax bill of £200.
You will be paying 40% tax on the £10,000 income, but will only get the same tax relief on the £9,000 of 20%, meaning you have a tax bill of £4,000 minus the £1,800 tax relief. A grand total of £2,200 tax will be due for payment. Obviously, this rises again if you find yourself in the 45% tax bracket, your tax bill on £10,000 is £4,500 minus £1,800 tax relief, leaving a tax bill of £2,700.
Changes to the tax relief mean that there are a few Landlords that are setting up Ltd companies in order to reduce the impact! However, selling a property from yourself to your Ltd company would count as a sale and therefore this money would be liable for Capital gains tax! It would be worth seeking legal advice and checking your figures before heading down this route.
The Chancellor has extended the Stamp Duty holiday until the End of June 2021, which applies to the first £500,000. A property over £500,000 which have stamp duty of 5% applied to the sale.
From July to the end of September this will be reduced to £250,000 before reverting back to the regular cut off of £125 000 at the beginning of October 2021 when 2% stamp duty will apply up to £250,000 when t changes to 5%.
However, from July to the end of September genuine first-time house buyers will still pay 0% stamp duty on homes worth £500,000 or less. There is however still a 3% stamp duty on all second home buyers.