Find out more about tax rates for residential landlords
Like all business owners, landlords need to pay tax to HM Revenue and Customs (HMRC) – and failure to do so can incur heavy fines. If you’ve recently become a residential landlord and are new to tax rates, it can be a confusing web to untangle. The following guidelines should help you get started and improve your understanding of residential landlord tax rates.
Do I need to pay tax?
There are different landlord tax rules for residential properties, furnished holiday lettings and commercial properties. A residential landlord is one whose property is let for tenant occupation for non-business purposes. In contrast, a commercial landlord’s properties are used for tenants’ business purposes (such as shops and offices).
If you or your company owns residential property, you must pay tax on the profit you make. If HMRC finds that you have not paid the tax you’re required to, you could be charged a penalty. While most residential landlords will need to pay tax, there are some exemptions:
- If you earn less than £2,500 a year from property rental, you will not need to pay tax – but you must still report this income to HMRC.
- If you are only letting out a furnished room or floor in your own house or flat, and your rental earnings are below £4,250 per annum, you will not need to complete a tax return. If you earn more than £4,250, you must complete a tax return. You can then opt into the Rent a Room scheme, for which you must register as a residential landlord, and can claim this income as a tax-free allowance.
Regardless of whether you need to pay tax, you must inform HMRC if you start renting out property. In order to fill in your tax return and pay tax, you’ll need to register as a Self-Assessment tax payer.
What are allowable expenses?
In order to pay tax, you will need to know the earnings and expenses associated with your business as a residential landlord. HMRC permits you to deduct allowable expenses from the earnings you’ll be taxed on. Allowable expenses are also known as ‘revenue expenses’, and are the costs incurred during the day-to-day running of your business. Allowable expenses for residential landlords can include:
- Letting agents’ fees (including fees to prepare inventories).
- Legal fees associated with the day-to-day management of your rental property.
- Accountants’ fees.
- Landlord insurance, such as building and contents insurance.
- Interest on property loans (mortgages).
- Costs associated with property maintenance and repair (excluding improvements).
- Utility bills (gas, water and electricity) – unless paid by your tenant.
- Ground rent and service charges.
- Council Tax – unless paid by your tenant.
- Domestic services (such as cleaning and gardening).
- Other costs directly associated with renting out a property (such as phone calls, stationery, advertising and commuting to and from the property).
- You may also be able to deduct a wear and tear allowance or a renewals allowance (see below).
Not included under allowable expenses is anything that falls under ‘capital expenditure’. Capital expenses are any costs that are incurred when trying to increase the value of a property, such as renovations and extensions, and any repairs beyond those for wear and tear. Buying a new property is also regarded as a capital expense. Where work has both a capital element and a repair element combined, it may be necessary to allocate the expenses accordingly.
There is an exception if you’re letting out a fully furnished property, as you can claim 10% of your net rent as a ‘wear and tear allowance’. Net rent is the rent you receive minus any costs you pay that a tenant normally would, such as council tax. You may instead be able to claim capital allowances on replacing furniture and equipment – called a ‘renewals allowance’.
You will not be able to claim both wear and tear and renewals allowances on the same property, so it’s worth figuring out which option would be of most value to you before you claim. In the case of furnished holiday homes, you will only be eligible to claim for these exemptions if you fulfil certain conditions.
Stamp Duty Land Tax when buying the property
If you’re buying land or property that costs more than £125,000, you’ll need to pay Stamp Duty Land Tax. The amount you pay is calculated as a percentage of the property’s value. This is:
- 2% on properties between £125,001 and £250,000.
- 5% on properties between £250,001 and £925,000.
- 10% on properties between £925,001 and £1,500,000.
- 12% on properties above £1,500,000.
Working out your net profit
The figure on which your tax will be based is your net income. If you have more than one property, HMRC will treat them all as one business, which means you’ll need to work out your cumulative net profit or loss. If you own properties both in the UK and abroad, your overseas properties are treated separately. To work out your net profit you’ll need to:
- Add together all your rental income.
- Add together all your allowable expenses.
- Take the expenses away from the income.
If you find you have made a loss, you can offset your losses against future profits by carrying it forward to the next tax year. If you have other properties, you can also offset your losses against profits from other properties. If you own the property personally, your profits count as earnings for pension purposes.
Residential landlord income tax rates
The rate of tax you pay depends on your total taxable income (also known as ‘net income’) above your Personal Allowance. For most people, their Personal Allowance will be £10,600 for the tax year starting April 2015/16. If you earn £10,600 or less per year, you do not have to pay any tax. If you own property jointly with your spouse, you may be able to combine your tax allowances.
For those who earn more than £10,600, you’ll fall under one of three tax rates:
- Basic rate 20%: Everything you earn between £10,600 and £42,385 will be taxed at 20%.
- Higher rate 40%: Everything you earn between £42,385 and £150,000 will be taxed at 40%.
- Additional rate 45%: Everything you earn over £150,000 will be taxed at 45%.
You might find it useful to create a separate bank account for your rental income, to make it easier to handle and understand your finances.
Filling in a tax return
Residential and buy-to-let landlords will normally need to fill in a tax return to declare rental income. If your total rental income is over £15,000 per year, you will need to fill in a full tax return that includes a breakdown of all your expenses. Those who earn less may be able to complete a simpler four-page return form. The tax return is also used to declare any capital gains or losses generated through selling the property.
On your tax return, you will need to enter your rental income and your expenses. If you are filing your return online, you will need to go to the UK property pages of the Self-Assessment service on the HMRC website. The online service will automatically calculate your tax bill. The tax due is collected through the Self-Assessment service, usually with a tax bill that is due by 31st January each year.
If your rental profit is low and you are an employee or pensioner, you may be able to pay tax through Pay-As-You-Earn (PAYE) instead. If your rental profit is less than £2,500 a year and your gross rental income is less than £10,000 a year, you can ask HMRC to collect any tax due through your PAYE code. You will still need to send HMRC a statement of your rental income and expenses each year.
As property income is treated as ‘unearned income’, you will not need to pay National Insurance contributions (NIC).
Selling your property
If you decide to sell your property, you may be able to claim Capital Gains Tax (CGT) relief for business assets that have increased in value (for example, due to the addition of a conservatory). You will need to pay capital gains tax whenever you sell an asset, such as a building, land or lease. Basic rate taxpayers pay capital gains tax at 18% while those in the higher rate bracket pay at 28%. Keep in mind that the profits you get from selling your property may place you in a higher rate tax bracket.
Similar to income tax, you may be able to offset some of your expenses against your capital gains tax bill, reducing the amount you have to pay. There are a variety of possible ways you may be able to deduct from your capital gains tax bill, including using ‘private residence relief’ if you have lived in the property you are renting out.
Inheritance tax is paid if a person’s estate (properties, money and possessions) are worth over £325,000 when they die. If your properties as a residential landlord go above this threshold, the executor of your will, or the administrator of your estate, will pay 40% of the value of your estate to HRMC. This rate may be reduced to 36% if you leave 10% or more of your estate to charity. The rules regarding inheritance tax can be complicated, so it is advisable to seek professional advice.
Trading income for non-residential landlords
While residential landlords receive a ‘rental income’, owners of hotels, guesthouses and B&Bs earn what’s called a ‘trading income’. If you are running a trade, you are treated as being self-employed, and you will need to register as self-employed and pay taxes through the HMRC self-employment system.
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