Lucy Mangan – Partner
Landlords are required to disclose their rental income on their annual tax return. Below is an overview of the income and expenses that could be included when calculating rental profit.
From 6 April 2017, individual landlords are required to report rental income on a cash received basis, unless gross property income exceeds £150,000 for the tax year, or an election is made not to use the cash basis. If gross property income exceeds that limit, or you make the election, you have to report rental income on an accruals basis. This means you are taxed on the rent payable in the period spread evenly over the rental contract, regardless of when you actually receive the payment of the rent.
The normal types of income to be included as rental income would be:
- Rents paid by your tenants
- Any money retained from your tenants’ deposits to pay for dilapidations
- Insurance proceeds received in lieu of lost rents
- Premiums received
Below is a list of typical expenses that you may incur in letting your property. This list is not
- Rent you pay under a lease for the property (ie if you sublet)
- Council Tax/ business rates
- Water rates
- Service charges and ground rents
- Utility bills
- Property, contents and lost rent insurance.
- Exterior and interior painting
- Damp treatment
- Stone cleaning
- Roof repairs
- Furniture repairs
- Repairs to any kind of machinery supplied with the property
- Travel expenses specifically linked to the management of the property (HMRC will not accept claims for travel between your home and the letting agents office)
- Telephone calls relating to the letting of your property
- Rent arrears if you do not expect to ever receive the rent due
- The costs of obtaining a loan or an alternative finance arrangement to buy a property that you let. However please see below for restrictions of this relief from 2017/2018.
- Any interest on such a loan or alternative finance payments. Please see below for restrictions of this relief from 2017/2018.
- Management fees paid to an agent to cover rent collection, advertising and similar administrative expenses
- The normal legal and professional fees for renewing a lease can be deducted if the lease is for less than 50 years. You can also deduct the professional fees incurred in evicting an unsatisfactory tenant, with a view to re-letting, or in appealing against a compulsory purchase order.
- If you also provide services to your tenants, such as gardening, porterage, cleaning or something like communal hot water, you can claim for the associated costs if you can demonstrate that they were for the let property.
- A proportion of our fees will also be deductible.
- Any revenue expenses you incur “wholly & exclusively” for the rental business will be deductible.
Following the abolition of the wear and tear allowance in 2016 all landlords are now entitled to tax relief in respect of actual replacement of items regardless of whether the property is let fully or partly furnished. The replacements of the following items are covered:
- Moveable furniture
- Furnishings (carpets, linen, carpets)
- Kitchenware (crockery and cutlery)
- Appliances including moveable white goods such as fridges , freezer’s but not appliances that are built into the property such as ovens etc.
The relief is only available for the cost of a like-for-like replacement asset (or nearest modern equivalent) plus any costs incurred in disposing of the asset being replaced. The initial cost of furnishing a property would not be an allowable expense.
Properties that qualify as a furnished holiday letting business can claim capital allowances for items bought in letting the property (such as furniture) as in previous years.
MORTGAGE INTEREST AND OTHER FINANCE COST RESTRICTIONS
Changes were introduced from 6 April 2017 which change the way tax relief is obtained for finance costs incurred in respect of residential properties rental businesses. Finance costs include interest on any loan taken for the purpose of generating income from residential property and any incidental costs of obtaining finance such as broker fees etc.
Prior to 2017 relevant interest costs were able to be fully deducted against income to reduce taxable income. The new rules instead allow for tax relief via a tax reducer. The tax reducer is calculated by taking your finance costs and multiplying them by 20% (the basic income tax rate). The resultant figure is then deducted from your tax liability. The 20% tax reducer will be restricted to the lower of:
- Finance costs incurred in the year;
- Rental profits of the year (net of any brought forward losses);
- Your total income
If there are any excess finance costs after this restriction they can be offset against future rental profits in the same way.
The restriction was phased in from 2017/2018 over 4 years as shown in the table below. As we are now in the 2020/21 tax year the rules have been fully phased in.
|Tax Year||% Allowable Finance Costs||Reducer|
To illustrate the potential impact of this change – Let’s say you have a profit of £30,000 before interest and the mortgage interest paid was £20,000. Under the pre 2017 rules the taxable profit would be £10,000. For a higher rate (40%) taxpayer the impact of the rules is as follows:
|Profit before finance||30,000||30,000||30,000||30,000||30,000|
|Tax @ 40%||4,000||6,000||8,000||10,000||12,000|
|Tax reducer @ 40%||(1,000)||(2,000)||(3,000)||(4,000)|
It is important to note that the tax reducer will only be deducted from your overall tax liability. Your gross rental profits before the interest deduction may therefore be significantly higher which can also have a knock -on effect on your future entitlement to the tax-free personal allowance or may create a tax charge for any child benefit claimed.
WHAT ISN’T RESTRICTED?
FORMING A COMPANY
The restriction of financing costs also does not apply to companies unless they fall within the Corporate Interest Restriction rules which requires considerable net interest costs (in simple terms £2m plus but the rules are complicated). Therefore some landlords may find holding a property within a company a viable alternative. Whether it is more or less tax efficient to hold a property within a company depends on several factors such as your total rental income, your finance costs, levels of other income, what profits would need to be extracted from the company and how you currently hold the property. One size does not fit all and you need to consider carefully whether setting up a company is right for you in your circumstances.
If you already hold a property portfolio personally, incorporating these into a company would also give rise to stamp duty land tax charges and, potentially, capital gains tax based on the current value of the properties.
FURNISHED HOLIDAY LETS
The restriction of financing costs does not apply to properties that qualify as furnished holiday lets. However, in order for a property to qualify you need to meet very stringent conditions (see section on furnished holiday lets below). If your property is usually let for long periods of time it is unlikely that you will be able to convert your property into a furnished holiday letting business.
FURNISHED HOLIDAY LETS
If you meet the conditions of a furnished holiday let you will be able to claim capital allowances on the furniture and fittings provided with the property.
Furthermore, on sale the capital gain arising should qualify for the 10% Business Asset Disposal Relief (formally Entrepreneurs’ Relief) rate of tax, rather than the full rate, currently 28%, provided the conditions have been met for the previous 12 months.
To qualify as a furnished holiday let all of the following qualifying conditions must be met:
- Availability: the property must be available for commercial letting as holiday accommodation to the public for at least 210 days during period
- Letting: the property must be commercially let as holiday accommodation to members of the public for at least 105 days during the period
- Pattern of occupation: not more than 155 days must fall during periods of longer term occupation (more than 31 days)
Further details regarding furnished holiday lets can be found on the HM Revenue & Customs website here:
If you rent out a spare room in the property you are currently living in you can claim rent-a-room relief. This allowance is up to £7,500 in a tax year. So long as the gross rental income received is below the limit it is exempt from income tax. If the rental income is above this amount then you have the option of paying tax on the excess above this threshold or using the normal rental income & expenditure rules as outlined above.
ATED (Annual Tax on enveloped dwellings)
The ATED rules apply to residential properties held by non-natural persons, most commonly companies. They apply if the market value of any single property exceeds £500,000 at acquisition or at a valuation date set by HMRC, whichever is later. The last revaluation date was 1 April 2017 and the next expected revaluation date is 1 April 2022.
Any companies falling into ATED need to register with HMRC and determine if an ATED charge arises. If a charge does arise, a full ATED return must be submitted to HMRC each year. Relief from the charge is available for properties which are rented out to third parties, but the relief is not automatic, and a relief declaration return still needs to be submitted to HMRC or penalties will arise.
Care should be taken if properties are to be rented to connected parties as even if full market rent is charged no relief from ATED is available.