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How is rental income taxed?

In the UK, you have to pay tax on most of the money you earn, which includes money you receive from letting property. Here, we take a look at the tax implications of being a landlord and running a property business.

 

The decision on how your income is taxed is decided by the incumbent government’s budget, which happens on an annual basis, normally in November. You’re not taxed on your property income in isolation – it’s added to the rest of the income you earn each year, then the total amount is taxed accordingly. As such, before letting, you’ve got to be sure you know exactly how earning money from property might affect your overall tax position.

For instance, if you currently receive any benefits, such as Child Benefit and the rental income takes your total income above £50,000, you could incur a ‘High Income Child Benefit Charge’ and lose some or all of those financial benefits. And if the income from property takes your earnings over £100,000, you need to know that your personal allowance – the amount of money you can earn ‘tax free’ – will be reduced.

However you’re taxed currently, bear in mind the amount you pay can change each year, as can the rules on tax. We’d suggest the best route forward is to take professional property tax advice to ensure you pay the correct amount of tax, while mitigating your liability.

Note: Income Tax can now be applied differently, depending on whether you’re based in England, Scotland, Wales or live overseas. The information below is based on the rules for England and Northern Ireland; if you live in another part of the UK, please check the latest rates on the GOV.UK website: https://www.gov.uk/government/publications/rates-and-allowances-income-tax/income-tax-rates-and-allowances-current-and-past.  If you live abroad visit: https://www.gov.uk/tax-uk-income-live-abroad/rent


How much can you earn without paying any tax?

Everyone who earns up to £100,000 is given a standard initial allowance before they have to start paying tax. This is called the Personal Allowance. In the last tax year (2018/19), the amount was £11,850; from 6th April 2019, it rose to £12,500. However, this tax-free allowance falls by £1 for every £2 you earn over £100,000, meaning that if you earn £125,000 or above, your Personal Allowance is zero.

How much income tax do you have to pay?

Above the Personal Allowance threshold, there are three tax rate bands. How much tax you pay depends on how much of your income falls within each band. From 6th April 2019:

  • Income from £12,501 to £37,500 will be taxed at 20%
  • The proportion of income above £37,500 and up to £150,000 will be taxed at 40%
  • Earnings of £150,001 and above will be taxed at 45%.

Source: https://www.gov.uk/income-tax-rates

What can you deduct from your property income?

When it comes to letting property, the rules are more or less the same as for any business: you’re allowed to deduct certain expenses from your gross income, to give a ‘net’ taxable income figure. As a landlord, this means you can take off most of the costs incurred in operating your buy-to-let, such as:

  • Letting agent fees
  • Insurance premium costs
  • Maintenance and cleaning costs
  • Utility bills (council tax, water bills)
  • Professional fees (legal, accounting)
  • If you own a flat, service charges and ground rent.

For more comprehensive information on allowable expenses, visit https://www.gov.uk/guidance/income-tax-when-you-rent-out-a-property-working-out-your-rental-income

Essentially, the cost of fees and other expenditure you’re allowed to deduct from your rental income is reduced, because you’re not paying income tax on that amount. For example, if you pay tax at the 20% rate and have deducted your lettings fees, you can view it as ‘saving’ 20% of the cost. If you pay tax at 40% or 45%, your letting fees are reduced by that amount.

There is an exception to this: the cost of mortgage finance. It used to be the case that you could simply deduct mortgage interest payments from your rental income, which was a real benefit to those in the 40% and 45% tax brackets. However, the rules changed as of the 2017/18 tax year, with the ‘allowable expense’ being replaced by basic rate tax relief.

The gradual transition from the old system to the new one is now in its third phase, so from 6th April 2019, you can only deduct 25% of your mortgage interest cost from your rental income; the remaining 75% is subject to 20% tax relief. By 2020/21, the whole amount of mortgage interest will simply have 20% tax relief applied. As long as this doesn’t impact on you being a basic-rate tax payers, you are unlikely to notice any difference, higher-rate tax payers – particularly highly-leveraged landlords with several properties – could see a significant increase in tax bills.

Another quirk of property income tax is that if one of your properties is making a loss, you may be able to deduct this amount from your overall property income to reduce the amount of tax you pay. However, losses on property income can’t be deducted from other earnings.

Finally, if you earn less than £1,000 from property, you might not need to pay any tax or even declare it. See https://www.gov.uk/guidance/tax-free-allowances-on-property-and-trading-income for more information.

If you’re registered for Self-Assessment, remember you have to file your tax return by October the same year if filing on paper, or January the following year if filing online. For those landlords owing more than £1,000 on their tax return, they may have additional payments on account to make in January and July.

Paying tax if you let property through a company

When you invest in property and let via a company, the tax on your rental income is different. It’s likely that the tax you pay on any income you withdraw personally from the company will be different too.

There are advantages to letting property in this way. The most significant is that the initial tax you pay on rental income as a company is typically lower than for a higher-rate personal tax payer. As it currently stands, the company tax rate is 19% (17% from 1 April 2020), versus 40% or 45% for individuals. You can still deduct all the mortgage interest and finance costs within a limited company, giving a corporation tax saving.

Although this may sound ideal, it’s not appropriate for everyone. You may still pay tax on the income you take from the company and might not be able to secure the same mortgage finance deal that’s available to you as an individual. Your operating costs are likely to be higher, as you have to pay for the administration of running of a company and submitting accounts. Also, when you sell the property, you’ll pay Corporation Tax, rather than Capital Gains Tax.

Whether you invest individually or through a company, property tax is complicated and can change annually. That’s why, at Marsh & Parsons, we recommend you always seek specialist property tax advice to make sure you pay no more or less than is legally required.

 

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