Given what has happened in the housing market over the past few years the buy to let market has been relatively buoyant as more people look to rent rather than buy. As a result many people are investing in buy to let properties both as a means of providing income but also as an investment for the future. Others are choosing to rent our their homes when they move rather than attempt to sell in a relatively flat property market. This guide attempts to answer some of the main questions people ask us in relation to the tax issues when you rent a property.
Buy to let properties and income tax
One common misconception in relation to rental properties is that if the rents being received are just covering hte mortgage payments then surely there is no taxable profit. Whilst the rental income received may only just cover the mortgage repayments on a buy to let property there is often still a reportable net income arising for tax purposes. This is due to the difference in treatment of expenses for tax purposes as certain expenses are not allowed as deductions against rental income for tax purposes. Any income received from rental properties is taxed at either 20%, 40% or 45% depending on your total income level.
If you do not currently complete a Tax Return then if you start receiving rental income you will have to contact the Inland Revenue and advise that you are now in receipt of rental income. Whether or not you are required to register for Self Assessment and complete a Tax Return each year depends on the extent of both your gross rental income and the profit generated from your rental property. For more information please see the HMRC Self Assessment Criteria.
Expenses allowable for tax purposes
Inevitably running a rental property will involve some element of expenditure on your part for the general maintenance of the property along with the administration of the letting. The majority of expenditure incurred will be allowable for tax purposes and can therefore be set against your total rental income to arrive at the taxable income. However, some expenses are specifically disallowed for tax purposes. We will now detail the expenses that are often associated with rental properties.
The following expenses are allowable deductions for tax purposes:-
Expenditure occurred in respect of repairs to the rental property are allowable costs for tax purposes. Repairs are defined as expenses that prevent the property from deteriorating and include repairs such as external and internal painting, stone cleaning, damp treatment, roof repairs, furniture repairs and repairs to lifts or other machinery or appliances.
Any expenditure incurred which relate to improvements, additions or alterations to the property are specifically disallowed. Any such costs are capital expenditure in nature and are added to the base cost of the property when calculating the capital gains tax position on your eventual disposal of the property.
Furnished Residential Properties
If you let a furnished residential property you can claim the net cost of replacing a particular item of furniture of fittings but not the cost of the original purchase when the item was first supplied in the property.
Prior to April 2016 there was the ability to claim a flat 10% wear and tear allowance and not claim the actual costs of renewing furniture & fittings. THowever this allowance has been scrapped and only the renewal of furniture or furnishings will qualify for tax relief.
Mortgage Payments (finance charges)
If your buy to let property is mortgaged you are allowed to claim any expenses incurred in connection with the obtaining of any loans or alternative finance arrangements (e.g. arrangement fees or booking fees) along with any interest incurred on any loans taken out to purchase the property. If you have owned your rental property for a period before it was let out please contact us as there are additional factors to consider in calculating the allowable finance charges. Please note that if your mortgage is a repayment mortgage then the monthly payments will include both capital and interest. As capital repayments are never allowable for tax purposes you will need to take account of this when calculating the allowable mortgage costs.
Restriction loan interest relief for ‘buy to let’ landlords
New rules have been introduced which restrict the amount of income tax relief landlords can get on residential property finance costs to the basic rate of income tax. Finance costs include mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans. No relief is available for capital repayments of a mortgage or loan.
Landlords will no longer be able to deduct all of their finance costs from their property income. They will instead receive a basic rate reduction from their income tax liability for their finance costs. To give landlords time to adjust, the change will be introduced gradually from April 2017, over four years. The restriction in the relief will be phased in as follows:
This restriction will not apply to landlords of furnished holiday lettings.
Legal and Professional Costs
Legal expenses in connection with the preparation of a lease for a year or less are allowable. Costs associated with longer leases are specifically disallowed. Other legal and professional costs that are allowable are:
Private use of your buy to let property
If your property is only let for part of a tax year and the rest of the time it is used for non-letting purposes then you must deduct the proportion of expenses that relate to the private use of the property. If for example you let your property for 8 months during a tax year and then live in it for four months then you can only claim two-thirds of any expenses (8/12) as the remainder is not incurred in the course of your rental business.
Renting a room in your home
If you rent a furnished room in your only or main home then you are entitled to an exemption whereby the first £4,250 of any rental income is not taxed. Please contact us if this applies to you as the rules are slightly different.
National Landlord Registration Scheme
The Antisocial Behaviour Act (Scotland) 2004 introduced a new compulsory registration scheme for private landlords and their agents. Under the terms of this act all private landlords must register with their local council before letting any residential property. Failure to do so is a criminal offence and local councils can prosecute those who fail to register.
Under this scheme all landlord will be held responsible for the actions of their tenants and will be required to take action to prevent any antisocial behaviour by tenants in their rental properties. Failure to do so will result in the local council taking action against the landlord. Registration is not automatic and all landlords must pass a qualifying test to ensure that they are a ‘fit and proper person’ to manage a rental property.
Tenancy Deposit Protection Scheme
Since July 2012, there has been a legal obligation for landlords who receive a deposit from a tenant, to lodge that deposit with a government registered tenancy deposit scheme within 30 days of commencement of the tenancy. This scheme was introduced to prevent some landlords from unfairly retaining deposits without sufficient reason and ensures that the deposits are returned to tenants quickly upon the end of a tenancy. One of the benefits of this scheme is that it offers a dispute resolution process where there is a dispute between landlords and tenants over the right of the tenant to have their deposit returned. Further information on this topic is available on the Scottish Government website at http://www.scotland.gov.uk/Topics/Built-Environment/Housing/privaterent/government/SGTD1
Selling your buy to let property
We frequently get asked about tax issues when a buy to let property is sold. Unlike properties that have been used as the owner’s home throughout their period of ownership, buy to let properties do not benefit from the Principal Private Residence exemption for capital gains tax (CGT) purposes. As a result any gains arising on the sale of a rental property, i.e. any increase in the sale value over the cost of purchase, is subject to capital gains tax. Subject to an annual exempt limit of £11,300 (2017/18) any gains are taxable at either 18% or 28% depending on the owner’s level of income. All higher rate taxpayers should expect to pay capital gains tax at 28% whereas those who earn less than £45,000 may pay CGT at a hybrid rate of between 18% and 28%.
Calculating the capital gains arising on the sale of a property can be complex, particularly where you may have spent money on the property over the years that could qualify as capital improvements or where you have at some stage used the property as your main residence. Given this complexity we would always recommend that you seek professional advice on this topic.
If you require any further advice or assistance in relation to reporting income from property or capital gains arising on the sale of property feel free to give us a call today or email us at firstname.lastname@example.org and we shall be happy to help.