When it comes to letting out a property, it pays to be on top of things from day one - particularly your tax affairs, which can be complicated and, at times, time consuming.
Even the most experienced landlords can fall foul of taxation, so rookies marketing their first property for rent should be well read when it comes to HM Revenue and Customs rules and regulations well before the lettings board goes up.
You pay tax on your income, right? Correct, and as profit from renting property is classed as income, you need to pay tax on that as well.
As soon as you start letting a property, you must tell HMRC to establish if you are liable. If you don't contact them and therefore don't pay, penalties could be around the next corner.
The amount of tax you pay on your rental property income will depend on which bracket you fall into. If you are already a higher rate tax payer through your job or because you own a substantial property portfolio generating a large income, you'll likely fall into the 40% higher rate or, potentially, the 45% additional rate bracket. If not, you will pay the basic rate of tax at 20%.
KEEP IT SIMPLE
When it comes to calculating your costs, it is well worth setting up a separate bank account for your rental income. The last thing you want when embarking on your property rental journey is muddled income streams - doing this will make it far easier to calculate profit and expenses.
At this juncture, it's important to note that you only pay tax on your profits, so deducting allowable expenses and knowing what is and isn't 'allowable' is hugely important.
SO, WHAT IS 'ALLOWABLE'?
Essentially, 'revenue expenses' are. These are costs associated with the day-to-day running and upkeep of your rental property, or properties, and can be offset against your income.
'Capital' expenses that increase the value of your property, such as renovation work, can't be deducted from your income tax bill but can potentially be offset against Capital Gains Tax liabilities - so, put that invoice for the new kitchen somewhere safe as you may need it further down the line.
CAN I HAVE SOME EXAMPLES OF ALLOWABLE EXPENSES?
Of course! Below are some of the most common expenses you can deduct from your rental income to reduce your tax liability:
- water rates, council tax, gas and electricity (if you pay them rather than the tenant)
- contents insurance
- costs of services, including the wages of gardeners and cleaners (as part of the rental agreement)
- letting agents' fees
- legal fees for lets of a year or less, or for renewing a lease of less than 50 years
- accountant's fees
- rents, ground rents and service charges
- direct costs such as phone calls, stationery and advertising for new tenants
WEAR AND TEAR
Prior to George Osborne's now infamous-among-landlords Budget of 2015, landlords could claim back 10% of the property's net rent (rent less costs paid by the tenant, such as council tax) for 'acceptable wear and year' even if no replacements or improvements were made.
However, from 2016, landlords have only been able to deduct expenses for 'wear and tear' that actually occurs.
For example, if a sofa that cost you £600 is falling to bits and is replaced with one that costs £400, you can only claim relief on £400. It's also important to note here that you cannot claim relief on kitting out your rental property at the start, only when you replace items.
However, you can deduct the cost of disposing of old items, so that £50 to safely rid yourself of an old cooker unit at the tip can be deducted at the end of the tax year.
WHAT ABOUT MORTGAGE PAYMENTS?
Ah, the big one...
Landlords cannot deduct mortgage payments on their rental properties from their tax bill. Up until last year, they could deduct mortgage interest payments but Mr Osborne's big announcement at the summer 2015 Budget concerned restrictions on buy-to-let tax relief.
That meant, from 2017, landlords can now only claim basic rate tax relief on finance costs like mortgage interest, interest on loans to purchase furnishings and fees from mortgages and loans.
To Mr Osborne's credit, the changes are being phased in over four years, giving concerned landlords time to adjust:
2017-18: Deductions from property income restricted to 75% of finance costs. The remaining 25% is subject to basic rate tax.
2018-19: Deductions from property income restricted to 50% of finance costs. The remaining 50% is subject to basic rate tax.
2019-20: Deductions from property income restricted to 25% of finance costs. The remaining 75% is subject to basic rate tax.
2020-21: 100% of finance costs subject to basic rate tax.
GIVE ME A WORKING EXAMPLE
Okay, so you have an outstanding buy-to-let mortgage of £150,000 and it's sitting pretty on a rate of 4%. That means your annual interest repayment would be £6,000, while your rental income from the property is £15,000 per annum.
Under the old rules, you would have been able to claim tax relief on the £6,000 in mortgage interest, meaning your taxable profit was £9,000.
Now let's skip forward a few years to 2021, when the entirety of section 24 of the Finance (No 2) Act 2015 will be in place.
Your mortgage interest payments are still at £6,000, but you can't claim tax relief on any of it so the whole £15,000 rental income generated is subjected to taxation - quite a leap from £9,000 in 2016. Moreover, if you are in the higher 40% tax bracket due to overall income you could be looking at a very large tax bill indeed.
IS THERE ANYTHING I CAN DO TO EASE THE PAIN?
Well, you have options, which is a good thing.
Many landlords are looking to place their portfolios under the ownership of a limited company, meaning your profit will be taxed at the 20% corporation tax rate. But this solution is not without its own complexities. Preparation of annual accounts, increased accountancy fees and other taxes such as PAYE, NIC and dividend tax may apply.
A second way of offsetting section 24 would be to increase your mortgage payments, cutting down on the amount of interest due if you have a capital and interest mortgage.
Alternatively, many landlords will increase rent to cover the costs of the legislation, but this could mean pricing yourself out of the local market - not to mention pricing tenants out of renting.
HOW DO I WORK OUT WHAT MY PROFIT IS?
It's simple. Add together your total income from your rental property or properties and then add up the allowable expenses mentioned earlier. Deduct the expenses from the income and that will give you your profit figure.
Make sure you complete your tax return accurately and in good time to avoid a penalty from HMRC - doing it online gives you an extra three months' grace!
WHAT ABOUT NATIONAL INSURANCE?
If you're lucky enough to list 'landlord' as your primary source of income then you'll need to pay Class 2 National Insurance.
This will also apply to those with more than one property in their portfolios, while your profits from property will need to be above £6,205. If your profit is below this figure, voluntary payments are an option in order not to create a 'gap' in your payment record that could affect your entitlement to the state pension.
HOW DOES STAMP DUTY AFFECT ME?
The autumn 2015 Budget outlined plans, which came into effect in 2016, to force buyers of second homes or additional buy-to-let properties to pay an extra 3% in Stamp Duty on top of the standard rates, on all properties purchased for £40,000 or more.
So, the figures for landlords would be as follows:
IF I WANT TO SELL MY RENTAL PROPERTY DO I PAY CAPITAL GAINS TAX?
Yes, you do if it has increased in value and it's not your main residence.
To work out the 'gain' in your property, you deduct the price you paid when you bought it from the price you are selling it for, less costs such as estate agent fees, conveyancing fees and, as we mentioned earlier, renovation costs - now where did you put that new kitchen invoice?
As soon as you have worked out your 'gain' amount, you can find out how much tax you owe by using a tax calculator service online.