Letting a property is a fantastic way to add an additional stream of income to your household. Investment properties can create cash flow, add to your net worth, and help you build generational wealth that you can pass on to your future generations.
Understanding your tax obligations and the tax on rental income is a crucial part of this process. There have been changes that may have significantly affected your rental business and the income you receive from your rental property.
Since you will be required to pay tax on any profit you receive from your buy-and-let property, comprehension of the tax credits and allowances available will help you save money this tax year… but where do you begin? What are the basics of rental property taxes?
What is Considered Rental Income?
According to HMRC, rental income is defined as “income you receive from tenants”. This is the totality of all rental income and includes payments made for water, electricity, repairs, furniture usage as well as cleaning and maintenance services. If there are other additional charges to your tenants, they may also be considered income. Contact HMRC with any questions regarding income from rental tenants.
At What Rate is Rental Income Taxed?
Rental income is taxed on a sliding scale which increases in relation to your taxable income. Your taxable rental income is added to your total taxable income, which can affect the tax band you are in. In the UK, the tax rates are as follows.
- £12,570 for Personal Allowance for which you are not required to pay any tax.
- Between £12,571 and £37,700 you are taxed at the basic rate of 20%.
- Between £37,701 and £150,000 you are taxed a higher rate of 40%.
- Anything above £150,001 is taxed at the additional tax rate of 45%.
How Can I Reduce the Tax Bill from my Rental Income?
Reducing your taxable income is desirable for anyone operating a buy-and-let property because, if you are still working a job, the majority of that income will be taxed at a higher rate. Your taxable rental income is your total rental income minus the cost of expenses and allowances.
HMRC provides UK citizens with allowances to help with their yearly tax obligations. Some are significant while others are more modest, but every little bit helps when it comes time to pay income tax. What are these allowances?
- Marriage Allowance: In the UK, as a married couple, you may be eligible to claim up to £250.
- Property Income Allowance: The property income allowance states that if you make £1,000 or less from rent, you do not need to pay tax on that rental income.
- Personal Allowance: all citizens are allowed an allowance of £12,570, which is completely tax-free.
Running a fully operational and functional rental property is the same as running a business and HMRC recognises this. You are allowed to deduct certain costs you incur for your buy-and-let residential properties, as long as the expenditures are for the purposes of operating and maintaining your rental property. What kind of expenses are allowed?
- Utilities, including power, water, heat and gas
- Legal or accounting fees
- Cleaning and landscaping
- Repairs and maintenance
- Council tax
- Travelling expenses (if you need to travel to manage your properties)
- Administration costs
- Finance costs***
What Expenses are Not Allowed?
Not all expenditures for your buy-and-let property are allowed to be used as expenses against your income. Most notably, capital expenditures that are for improvements to a home, and not for repairs to the property or maintenance, are not allowable expenses.
The easiest way to know whether a project falls under “maintenance” or “improvement” is to determine the purpose of the work. Improvements and maintenance, though similar, are different in the eyes of HMRC.
Improvements are projects and work that is meant to make a permanent or long-lasting enhancement to a property, often done to increase the value of that asset. Adding an extra bedroom or fully renovating a kitchen would be considered improvements.
Maintenance or Repairs are projects and work that is done to maintain and preserve the value of the property. Fixing a leaky roof, painting or replacing a broken toilet is work done to maintain the current value of that property and would be considered maintenance or repairs.
Can I Expense Interest Payments on my Rental Property Mortgage?
Before 2017, anyone operating a buy-and-let property was allowed to expense the entirety of their finance costs, meaning that all the interest paid on a mortgage was an allowable expense. As of April 2020, after a 3-year phase-out period, only 20% of the interest payments are now allowable as expenses against your rental income.
Are There Exceptions to the Rule?
Another allowance that you may be eligible to qualify for is the Rent-a-Room allowance. This enables you, as a landlord, to make the first £7,500 of rental income tax-free. How do you qualify for such an allowance? If you live in the residence that you are also earning rental income from, you qualify for the Rent-a-Room allowance.
Even if you don’t own the property or are using a platform like Airbnb for short-term rentals, this allowance would apply. If you are going to be using this allowance on your Self-Assessment form, you are not allowed to qualify for the property income allowance.
What Tax Do You Pay on Rental Income?
Everyone pays income tax. HMRC understands the need for abundant and affordable housing and when you own a buy-and-let property, there are authorised and regulated ways to reduce your overall tax burden.
Understanding your obligations, as well as the allowances and expenses which you are entitled to, can make a tremendous difference on the profitability of your rental property, as well as your tax obligations at the end of the year. Having a professional help you with your tax affairs can help with ensuring that you are maximising the deductions available to you.