1. Summary of Key Points
• Inform HMRC – Her Majesty’s Revenue and Customs – as soon as you first receive rental income.
• Keep all invoices and good records of costs incurred in relation to your property.
• Consider structuring your mortgages to make full use of the tax relief available on mortgage interest.
• It is normally better to have expenses attached to your rental property and not your home where you have a choice.
• Make sure you have funds available every 31 January and 31 July to pay your tax bills on time.
• Couples may benefit from having the property owned by the person who pays a lower tax rate.
• Capital Gains Tax will be assessed on the profit when you sell, but good tax planning can reduce the tax you’ll pay.
2. Background
The “buy to let” market has exploded in recent years. This note will deal with the main financial issues landlords have to deal with. UK tax law deals with four main types of rented property:
• Unfurnished lets – where the property alone is let without any contents.
• Holiday lets – where the property is let to many tenants for short periods.
• “Rent a room” – renting out part of the house you own and are living in.
• Furnished lets – where the property is let along with house fittings furnishings.
This note deals solely with the fourth – and most common – type of let. The tax treatment of the other three is very different. This note is a quick run through the main elements, there are numerous minor details not covered here.
3. Disclosure
If you’ve only ever paid tax through PAYE, the notion of disclosing information to HMRC will be new to you. Best practice is to write a letter to HMRC as soon as rental income starts coming in to you. They will then send you a tax return to complete shortly after the end of the tax year – 05 April. Failure to disclose the income can result in tax penalties and interest charges for late payment. However, if you make a voluntary disclosure and have made an honest mistake in not declaring the income, HMRC will look on this favourably in comparison to a taxpayer who:
• Appears to them to have deliberately not disclosed the income, or
• Has not made a voluntary disclosure, and HMRC identify the income in some other way – usually when the tenant declares the rental expenditure in some way, for example to the local Council.
On your tax return, if your gross rental income is under £15,000 you only need to include the income and the total expenses you are claiming to arrive at your taxable profit. If your income is over £15,000 then you need to disclose all the expenses separately.
4. Key Dates for Tax Year 2009-2010
• 6 April 2009 – start of new tax year
• 31 January 2010 – payment on account due for tax year 2009-10 unless this is your first year of letting
• 5 April 2010 – end of tax year
• 31 July 2010 – second payment on account due
• 31 January 2011 – last date to file tax return for 09-10, balancing payment for 09-10
If 2009-2010 is your first tax year of trading, then in April 2010 you should receive a note from the Tax Office confirming that they want you to file a 2009-2010 return. The last date you can do this without incurring a penalty is 31 January 2011, but it’s better to sort things out a few months before this.
Unless your taxable profits are very small, you’ll pay the 2009-2010 bill in 2 equal instalments – one due by 31 January 2011 and one by 31 July 2011. You will then need to pay by instalments for 2010-2011 on 31 January 11 and 31 July 2011, these will initially be based on estimates. You’ll need to file your return for 2010-11 by 31 January 2012 and at the same time pay a balancing amount for 2010-11 now that the actuals are known.
Finally, if your profits are small or your renting is loss-making, this can be dealt with through your PAYE code if you are in employment. This has the merit of avoiding the need to remember to have cash ready for payments every January and July.
5. Rent Receivable
Income from rental property is taxed on a “rent receivable” basis. Let’s say you have a contract where the rent is £2,000 per quarter, paid quarterly in advance from 1 April 2008. The “rent receivable” for tax year 08-09 is £8,000. This is the case even if the if the 1 April 2009 payment of £2,000 has not been received by the end of the tax year on 5 April 09. It was “receivable” during the 08-09 tax year so it counts as rental income on your tax return.
6. Allowable Expenses – Capital and Revenue
Tax is paid on the taxable profit from the rental, not the gross income. There are some complicated rules on what expenses you can claim and what you can’t. Before going into those in detail, it’s worth bearing in mind that the general principle is that:
• Expenditure deemed to be “Capital” – which arises by nature of owning the property as opposed to running it – is not a tax-deductible expense.
• Expenditure deemed to be “Revenue” – arising from running, maintaining and letting the property – is allowable.
The golden rule is to keep proper records of all the expenses you have in connection with the property. A good accountant can quickly decide whether you are allowed to claim them or not.
7. Mortgage Interest Payments
If you have an interest-only mortgage on the property, the monthly charges are 100% allowable. However, if you have a repayment mortgage then only the interest element of the monthly payments are allowable.
The following things are worth considering:
• If you own two properties – one you live in and one you rent – then purely from a tax viewpoint it will be better to have as much as possible of the rented property mortgaged.
• Purely from a tax viewpoint, it is better to have an interest only mortgage on a rented property with a separate vehicle – ISA, pension, etc. – to repay the debt at the end of the term.
“Purely from a tax viewpoint” – there are other considerations than purely the size of your tax bill:
1. You may prefer the relative security of a repayment mortgage in today’s volatile financial climate.
2. The terms available on a mortgage on your rented property could be so expensive that any tax savings end up being a lot less than the higher interest rates being charged to you by one of our newly risk-averse banks.
8. 10% “Wear and Tear” Allowance
Tax law recognises that from time to time a good landlord or landlady will be fixing TV sets, replacing carpets and so on. There are two ways of claiming for this – item by item is possible but normally most people elect to go for the other option which is:
10% of the gross rental income for the year
There’s no admin. involved, less work for your accountant to do, and no chance of the HMRC Inspector digging around to disallow anything from the 10%. This option is strongly recommended!
9. Renewals
From time to time you may need to replace things like washbasins, central heating and so on. Although these look a bit “capital” in nature, they are fully tax-deductible providing:
• This is not the first time such things have been installed.
• It is a genuine like for like. So a super-generous landlady installing a new jucuzzi-style bath with gold-plated taps would only be able to claim up to the cost of replacing the ancient old Shanks bath which had gone before it!
10. Other Tax-Deductible Expenditure
Having dealt with the items which people can trip up on, it remains to list those items which are all claimable as expenses and which rarely cause any problems:
• letting agent’s fees
• legal fees for lets of a year or less, or for renewing a lease for less than 50 years
• accountant’s fees
• buildings and contents insurance
• repairs to the property (but not improvements)
• utility bills (like gas, water, electricity)
• rent, ground rent, service charges
• Council Tax
• services you pay for, like cleaning or gardening
• other direct costs of letting the property, like phone calls, stationery, advertising
Note you can’t claim the costs of travelling to and from the property.
11. How Much Tax Will I Have To Pay?
To estimate this accurately you need an accountant – but then I would say that, wouldn’t I? But let’s look at a couple of typical examples of first-time renters in the 09-10 tax year and give ballpark estimates of the tax liability:
John Rent Receivable 20,000 Allowable Expenses 7,000 John has an annual salary of £70,000 under PAYE.
John has taxable rental profits of 13,000. He is in the 40% tax band so his tax bill is 40% of 13,000 = £5,200.
Jane Rent Receivable 20,000 Allowable Expenses 7,000, annual salary £28,000 under PAYE. Jane’s salary and rental profits, less personal allowance of 5,435, give her taxable income of 35,565 keeping her just under the 40% band which starts at 37,400. Her tax bill is 20% of 13,000 = £2,600.
12. Can Couples Save Tax By Good Planning?
If John and Jane from Section 11 were “an item” then in order to save tax they are better off buying the property in Jane’s name. It’s worth noting that the HMRC have powers to “unravel” transactions purely designed to save tax, but if the purchase is initially bought by Jane then the income tax bill of the couple will be lower. There may well be other considerations which outweigh the tax savings from having the property asset in Jane’s name.
13. Capital Gains Tax (CGT)
This is payable on any gain on the sale of the property. Not all of the full profit will be subject to the tax – up to £40k will be exempt – and everyone has an exempt band which is currently £10,100 per person. At present the rate of CGT is just 18%, but it’s not so long ago that the highest rate was 40% and it is one “soft” target for the next Government to repair the £200bn deficit.
The good news is that with careful planning the potential future tax bill can be greatly reduced. One action anyone on PAYE can take now is to make sure they declare any losses they are realising on, for example, sales of shares which have dropped heavily in 2008 and not recovered much by the sale date. These CGT losses can be carried forward indefinitely – most self-employed people who hire accountants will get this advice as part of the service, but people purely on PAYE may not be aware of it. You have nearly 5 years and 10 months to notify HMRC of such losses if you want to claim them – so for 2009-2010 you have until 31 Jan 16.
When you enter into negotiations to sell the property it is a good idea to consult an accountant or tax expert. The reason for this is that it’s possible you can reduce the tax bill by realising losses on other qualifying assets you own. But without knowing the likely size of the taxable gain on the property, or the rules on qualifying assets which seem to change with every Budget, a “do-it-yourself” effort at doing this could be costly.