Landlord Income Tax
What are a landlord’s income tax liabilities?
Tax liabilities for rental properties are assessed on the basis of income and capital gains tax. Landlords looking to avoid the latter need to be fully aware of the tax relief for their pincipal residence.
Firstly, let’s examine how the liabilities derived from a landlord’s income are calculated.
Income and expenses for tax purposes are assessed as a single letting business, so effectively, if a landlord has one or one hundred properties, Her Majesty’s Revenue & Customs (HMRC) takes the total figure rather than looking at the rental income from individual properties.
Income is assessed by tax years ending on the 5th April. Schedule A income is treated as investment income. As such any losses can only be carried forward and offset against Schedule A income and not personal income such as a salary. This means that it is important for a landlord to prepare a tax return for their rental properties even if they don’t expect to make a rental profit.
Taxable profit is the income that remains after all allowable expenses have been deducted. This means, a landlord’s taxable profit is calculated by taking annual rent and then deducting expenses. A landlord unless they are incorporated as a company will need to prepare details of their rental business as part of their end of year self assessment tax return.
Categories of allowable expenses on a rental business
HMRC separate expenses into 5 categories.
Legal & professional – Legal services for a remortgage, valuation fees, mortgage broker fees, landlord safety certificate costs, tenancy agreement costs, letting agent fees, admin cost to close a mortgage, membership fees to a professional body
Repair, maintenance & renewals – redecoration costs, appliance repair charges, plumbing, electrical repairs, etc
Rent, rates, insurance, ground rents, etc – landlord insurance, council tax charges, grounds rent
Cost of services provided, including wages – cleaning, meals
Other expenses – Telecom charges, utility bill costs, computer software, advertising costs, computer purchase (if used exclusively for the business – could be accounted as a capital allowance (see section on capital allowances below)
What are a landlord’s allowable expenses?
Repair and renewals
Can I still claim a 10% wear and tear allowance?
Where a rental property is furnished or part furnished; rather than to claim as each renewal arises it was possible to make a single claim of 10% of rent as a ‘wear and tear’ allowance. This was accepted by the Revenue as broadly equivalent to the cost of normal renewals of furniture. The advantage to landlords of this system was that they were able to claim a 10% allowance even if no expenditure had been occurred. However, if actual costs exceed 10% then the additional amounts were not claimable above the 10% net rent.
This 10% allowance was first dealt with until 5 April 2011 by way of an extra statutory concession B47 which allowed taxpayers to claim a 10% wear and tear allowance (WTA). For income tax purposes, the WTA was put onto a statutory footing from 6 April 2011 by ITTOIA 2005 s308A.
Following a Revenue consultation, it was decided to replace the WTA with a relief very similar to the renewals basis that existed until 2013 as an alternative to the WTA. The new rules are implemented for income tax purposes by ITTOIA 2005 s311A.
How to claim now for furniture, furnishings and appliances?
The Government subsequently announced changes to this option in 2015 which came into force on the 1st of April 2016 for Corporation Tax paying landlords and the 6th April for Income Tax paying landlords. It removed the option of the 10% allowance and instead landlords now have to claim under the new scheme entitled the ‘catchily’ named Replacement Domestic Items Relief (RDIR). Replacement Domestic Items Relief is available provided that the following 4 conditions are met:
i) the taxpayer carries on a property business in relation to land which consists of or includes a dwelling house;
ii) the expenditure is incurred on the replacement of an existing domestic item in the dwelling house (which ceases to be available for use in the dwho) with a new one which is provided solely for the use of the lessee.
iii) the expenditure is capital expenditure incurred wholly and exclusively for the purposes of the business.
iv) no capital allowances must be available for the expenditure.
RDIR is available to both part and fully furnished properties (the 10% allowance was only available to a fully furnished property).
The tax relief for domestic items under the RDIR is now the cost of the replacement item (on a like for like basis) along with the costs of disposing of the old item. Should the old item be sold then the relief for the replacement item needs to be reduced by the value of the sale. Where the replacement is superior to it’s replacement then the amount of the deduction is limited to an equivalent replacement. For example, if a single bed was replaced with a Super King then the allowance would be limited to the value of an equivalent single bed.
Beyond the fittings, such as furniture there will be renewals and repair to the building e.g. repair to the roof, bathroom and windows, etc. The Government announced changes to this option in 2015 which came into force on the 1st of April 2016 for Corporation Tax paying landlords and the 6th April for Income Tax paying landlords. It removed the option of the 10% allowance and instead landlords will have to claim on an item to item basis.
What constitutes fair wear and tear raises a real taxation hornet’s nest. When does a renewal become an improvement? The latter is not an allowable expense against income (although it can be offset against capital gains – see later under Capital Gains Tax( CGT).
There is, as with many tax issues, a grey area of when a renewal becomes an improvement. It is largely a question of fact and degree in each case whether expenditure on a property leads to an improvement and therefore become a capital expense. UPVC windows were considered for many years to be an improvement and therefore the expenditure counted as capital. However, in recent years HMRC have relented and accepted that UPVC is for most people the modern equivalent of wood and therefore is considered a renewal.
Another example of the way the HMRC approach the subject is their approach to the refurbishment of a fitted kitchen. For example, they consider that where a kitchen is refurbished, including work such as stripping out and replacement of base units, wall units, sinks, etc, retiling, work top replacements, repair to floor coverings and associated re-plastering and re-wiring. Provided that the kitchen is replaced with a similar standard kitchen then this is a repair and the expenditure can be off set against income. If at the same time additional cabinets are fitted that increase the storage space, or extra equipment is installed; then this element is a capital addition and not allowable and the additional expense should be apportioned as a capital cost. If the standard units are replaced by expensive customised items using high quality materials, the whole expenditure is then judged to be capital.
Loans and Interest
Most landlords will have borrowed money to finance their investment. When accounting for these costs it is interest payments alone that are an allowable expense. This means where a loan is a repayment mortgage; only the interest element of the loan can be offset against rental income. It is also possible for a landlord to offset other loans that have been taken out for the business. For instance, when one has been raised to finance a new kitchen or extension of the rental property. It should be quite clear in these cases that the loan is specifically for the business and where possible documentary evidence should be available (just in case the revenue raises an enquiry on the matter). Therefore, if a loan is arranged, a landlord can try to separate it off from your personal finances. This could be done by using it to set up a separate business account.
Changes to tax relief for residential landlords in 2017
The Government is bring in changes to the way income tax is levied for landlords on their rental properties following the Budget in 2015. in the Finance (No. 2) Act 2015 as amended by the Finance Bill 2016. This is important so landlords take note.
The tax changes are due to be phased in over a 4 year period from April 2017. For some higher rate landlords the loss of mortgage interest relief will have a devistating impact on cashflow and their business model.
In essence landlords are no longer able to offset all there loan costs against rental profit as they have done in previous years. Some property investors have been asking whether they should incorporate their residential investment business.
The changes will affect all residential properties owned as an individual, partnership or trust. However, interestingly landlords who hold their rental properties in a company are exempted from the changes (see above). In the case of a: UK resident company, non UK resident company or a landlord or a Furnished Holiday Let taxation will allow landlords to receive relief for interest and other financial costs.
The phased implementation of the income tax changes are due to start in 2017 when a landlord will only be able to offset 75% of their loan costs against their rental income, this will be accompanied with a 25% deduction in their tax at the 25% basic rate in the form of a tax credit paid at the basic rate of tax. In 2018 the amount of loan costs will reduce to 50% (50% basic rate tax credit) and by 2020 none of the loan costs will be off setable against rental income replaced instead by 25% basic rate tax credit.
There have been protests about the way tax changes have been brought in and despite a legal challenge to the tax changes on buy-to-let properties the changes have stood backing up the principle that the government can pretty much tax what they like and how they like (there is no law on tax fairness).
How landlords can save tax on their rental profits?
Firstly, landlords should never evade paying the tax due on their rental properties. This is illegal and could result in large fines or interest bills being payable. Tax avoidance is perfectly legal and allows a landlord to pay as little tax as is legally due. We have a number of tested approaches for a landlord to pay the least amount of income tax on their rental properties. A landlord should claim their allowable tax expenses on a landlords rental property. These expenses include the following on top of any finance costs:
The cost of travel when travelling to and fro to the rental properties. This includes meetings with contractors as well as the tenants.
All advertising costs such as print and digital advertising for a landlords rental property.
Telephone calls and text messages to tenants and others in connection with managing the property portfolio.
The cost of gas safety certificates.
All maintenance costs in connection with the rental properties.
Finance charges such as bank charges.
Subscriptions to trade and industry magazines and websites.
Professional and advisory fees
Most landlords will have borrowed money to finance their buy to let investment. This will include mortgages, personal loans or even funds from family and friends. The interest charges on all these loans can be off set against rental profits.
Splitting a landlords rent
A landlord is perfectly able to put a buy-to-let property into joint ownership but then split the rent in the most tax efficient way.
Landlords carrying forward losses
Landlords need to carry forward any rental losses. This is a legitimate accounting practice and will reduce your rental profits in future years.
Any expenses that occur even when a landlords property is empty (void period) then these such as council tax, utility bills are all deductable even though a rental property remains empty.
Landlords home office expense
Every landlord has a home office even if they don’t realise. Have a look at the article on claiming against these expenses.
Apportionment against rental business expenses
Landlords don’t always realise that they can apportion some expenses against their letting business. This is where the expense is incurred ‘wholly and exclusively’ for their letting business.
Landlords should get their tax return in on time
Landlord should ensure that they don’t file their tax return late. For online filing of their tax return a landlord should go it by the deadline of 31st January. Paper copies of the tax return are required by 31st October.
What is the deadline for a landlord income tax return?
The self-assessment deadline for landlords preparing a paper tax return is the end of October and any paper return received on or after the 1st November will automatically incur a £100 penalty. A daily penalty of £10 is liable for any landlord who fails to deliver the paper tax return within 3 months of the deadline.
For most landlords it makes sense to submit the self-assessment return online through the HMRC tax portal. The deadline for online submission is the 31st of January. Landlords are always advised not to leave it to the last minute. The HMRC website has buckled before under the pressure of submissions.
The critical part of the self-assessment form that relates to a landlords rental portfolio is the Land & Property Section of the form. The paper form that has to be filled in is also known as the Self Assessment UK Property SA105 and a copy can be downloaded a viewed using the Government website.
Can landlords prepare their income tax return online?
The simple answer is yes. A landlord needs to register for self-assessment to be able to complete the form online. Once a landlord has received the Unique Taxpayer Reference. A landlord will also need a HMRC online account sometimes known as a Government Gateway Account to be able to send a self assessment tax return online. It takes approximately 7 working days to set up the online account because HMRC posts out an activation code, which is required to activate a landlords account.
The above all relates to the government mechanics of submitting a landlords tax return online directly to the HMRC. Before a landlord does this, they will need to calculate the tax liabilities.
How can landlords calculate their tax liabilities?
Property Hawk’s property management software PM3.0s allows landlords to calculate the tax liabilities for their rental business. The software is free to use and has been running since 2006. To do this a landlord needs to start by sign up for the online software:
1. Once registered a landlord needs to add the details of their property portfolio including details of each property and the tenancies together with the rents being received.
2. Landlords will then need to add in the rental expenses specified above.
3. Another big expense and probably the biggest for most landlords is the costs of financing their investments. Mortgage interest charges should be included as an expense and offset against a landlords tax liability.
4. Having added in the details referred to above landlords can then access the data within the tax tab accessed on the left hand tool bar. This will give a break down of the income and expenses for a landlords rental business by tax year. A landlord with a rental business generating less than £15000 per annum has the choice by concession with HMRC to calculate their rental business tax liabilities on a cash basis. This means that expenses and rents are only accounted for when they are received and not when they fall due. For larger rental businesses landlords will need to use the accruals system, which records the details when payments are due. It is possible to use both methods of accounting with PM3.0s property management software.
5. Once the income and expenses have been calculated for the financial year it is then possible to add these details directly into the landlords SA (105) within the HMRC online self-assessment form.
There are also a number of online software providers that allow people to prepare their own self-assessment form and then submit the form including the Land & Property section direct to HMRC.
These software suppliers will charge landlords to use their software.
Why not try Property Hawk’s new landlord income tax calculator for FREE.
Often confusion arises over eligibility of items of expenditure allowable as an expense when calculating income tax liabilities. I have therefore listed below a number of these items under the headings; non allowable and allowable expenses:
1. fees in purchasing the property – included in the base cost when calculating any potential capital gain
2. expenses in connection with the first letting of a property for more than one year
3. repairs covered by insurance. Where a repair is covered then it is only the excess that should be claimed as an expense
4. replacement of a ‘bog standard’ kitchen with a ‘top of the range’ bespoke designer kitchen – classed as capital expenditure. See HMRC website’s property income manual in the Practitioners Zone for detailed guidance and explanation on repair, reconstruction & improvement.
5. architect or building regulation application to alter property – classed as a capital cost
6. capital expenditure of providing the means of travel (normally a car) is not allowable as a deduction.
1. costs of remortgaging a rental property such as surveyors, solicitors and mortgage brokers fees
2. fees received in evicting a tenant where a property is to be re-let
3. accountants fees!
4. cost of any services provided e.g. laundry, gardening and porter.
5. ground rents
6. any interest payable including personal loans and overdrafts which have been used to fund the investment
7. UPVC double glazed windows are now classed as a repair & therefore a revenue item even where they replace single glazing units.
8. costs of evictions e.g. legal costs, court costs, investigations
9. subscription to landlord organisations
10. ‘revenue costs’ of a car (the running costs e.g. fuel, road tax) of trips to rented property, it must be your primary purpose to visit the rental property. However, as the Revenue put it, if you stop off on the way to collect a paper this is ok! Where as if you set off to buy a paper and then visit a property on the way this is not. I think we all now how landlords would perceive this particular journey.
Remember – there’s lots more tax advice in the Landlords Bible including helpful examples of how to go about calculating your capital gains tax liabilities.
What are the other taxes payable by landlords?
Council tax – the inescapable local property tax
Landlords are generally not liable for the Council Tax where the property is let; this is a tenants responsibility to pay the tax. The one exception to this is where the let property is a House in Multiple Occupation (HMO) where a landlord is liable for paying the tax charge. Council Tax is charged based on property valuation bands. The band that a property is placed is down to the Valuation office. A landlord can challenge their banding if they believe that the property has been allocated the wrong band.
The major changes that have affected rental properties is for empty properties. This maybe in between a letting or whilst a property is being refurbished. In the good old days landlords would have a grace period whilst they refurbished a property and it was uninhabitable and no council tax would be payable by the landlord for say a 12 month period. In addition the Government gives an option to councils to give a landlord a discount on empty properties. In previous less cash strapped times many councils would give a landlord a grace period of say 6 months with a 50% reduction. No longer. Most councils will now demand the full council tax for any refurbishment period and also for periods in between letting. Landlords are now truly an easy target for cash strapped councils so expect no or little generosity not even the 25% reduction given to single occupants. The logic of an empty property where the absentee landlord owner is using NO local services but paying more than a single occupant who clearly will be needing some level of local provision makes NO sense and illustrates the confusion that our local property taxation has descended into.
Tax for purchasing a buy-to-let (SDLT)
Unfortunately, landlords are now subject to tax even when they first purchase their buy-to-let whatever the value. Since April 2016 with the coming into force of the all purchasers of a buy-to-let property are subject to a minimum 3% purchase tax charge.
Have a look at our detailed guidance for full details of landlord Stamp Duty Land Tax including rates and details of a FREE SDLT calculator.
Landlords Energy Saving Allowance (LESA) (ended April 2015)
Landlords were previously able to offset their costs of insulating their buy-to-let property against their potential tax bill through the Landlords Energy Saving Allowance (LESA). This handy tax break unfortunately came to an end in April 2015 when the government withdrew this green tax break on buy-to-let property.
Non – standard lettings
So far I have referred to the tax treatment of a ‘standard’ buy-to-let property rented on an Assured Shorthold Tenancy. There are two categories of residential rentals that are treated slightly differently by the Revenue. These are where somebody rents a room in their house and a furnished holiday let.
Rent a room
Under this system a landlord is allowed to rent out a room in their own home without having to pay tax providing the rent is no more than £7500 pa. If it is more than this, the taxpayer has the option to have the excess income (i.e. above £7500) taxed as a Schedule A rental profit. Otherwise the entire rent will be taxed in the usual way on the profit from the gross receipts minus allowable expenses. This is halved if you share the income with a partner or another party.
Furnished holiday rentals
These are treated slightly differently to the Inland Revenue from a standard residential let. This is because of the amount of management time involved and the relatively short rental periods. They are therefore are therefore classified as a business rather than an investment. Consequently a different tax treatment applies.
To qualify as a holiday let the following criteria must be met. The property must be:
- Available for holiday let at least 140 days a year
- Actually let for 70 days a year
- Not occupied by the same person for over 31 days in 7 months
The main advantage to landlords with a holiday let is that the activity is regarded as a trade and is assessed under Schedule D. Therefore, any losses can be offset against an individual’s personal income, which includes their salary.