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Written by Ray Coman
Profits for letting a property in the UK are subject to tax. Rental profits are calculated based on when income and expenses accrue, rather than when cash is paid or received. The resulting profit or loss is assessed to tax annually for the year to 5 April. Where a taxpayer has more than one UK property, all rental income and expenses are pooled to determine the net profit or loss for the tax year. Overseas property income is pooled separately, so that a loss on a UK rental property cannot reduce a taxable profit on foreign rents. This guide provides an overview of the tax system which applies to property income.
The interest component of borrowings used for a property business can be deducted against rental profits. It is possible to deduct interest on borrowings up to the value of the property when first let. There may therefore be opportunities to re-mortgage, release extra funds from a property and deduct the additional interest from taxable rental profits.
Interest on a loan obtained for business purposes can be deducted from business profits, regardless of which asset, if any, is used as security for the loan. Indeed, it is common practice for a lender to obtain security for a business loan on property which is not used by a business. A common example might be a loan used to start up a business secured against the borrower's home. Similarly, interest from a loan secured, say, on a person's home, would be deductible against rental income from a second property, provided that the purpose of the loan was for the property business. Notwithstanding, where the purpose of a mortgage is to buy a home, interest would not be available to reduce taxable profits on the property which is let. In practice, borrowers may have a preference for securing a mortgage against a let property to protect their home from a failure in the letting business.
Interest can be deducted for a period where the property is vacant but available for letting. However, where a landlord has not been actively attempting to let the property, mortgage interest would not be tax deductible.
Interest relief will be withdrawn between April 2017 and April 2020.
Repairs and renewals
Costs which are required to repair or maintain a property can be deducted from rental income. Improvements cannot be deducted from taxable profits. Capital improvements are included as a cost when assessing liability to capital gains tax on disposal of the property. To illustrate, repairs to a roof would be deducted from profits liable to income tax whereas the cost of a loft conversion would be deducted from gains liable to capital gains tax.
Expenditure required to bring a property into a state in which it can be let would be capital in nature. For instance, the creation of a separate entrance in a property divided into multiple dwellings. Expenditure required to restore a property to its condition when first made available for letting will be deductible against rental profits.
The cost of a renewal is usually treated in the same way as a repair. If there is an improvement element to a renewal then the costs would be dealt with as a capital improvement. Expenditure for re-fitting a kitchen would normally be considered a renewal unless there has been significant upgrade. In assessing a renewal, HMRC will make allowance for the nearest up-to-date equivalent to what is being replaced. In particular, HMRC have stated that the renewal of single glazed with double glazed windows would be considered as a renewal rather than an improvement.
If a property is let furnished, there are two alternatives for obtaining tax relief. Following the renewals basis, no tax deduction is allowed on original purchase of the asset. However, on replacement of the asset, the replacement cost of that item of furniture is deducted from tax. It is acceptable to deduct the whole amount of the replacement, even if replacement cost more, for instance due to inflation. Any improvement value in the replacement cannot be deducted.
The more popular alternative is to use the wear and tear allowance. A landlord may deduct from rental profits an amount equal to 10% of 'net rent.' For wear and tear purposes, net rent is rent less the cost of water rates and council tax, provided these costs are paid by the landlord.
The wear and tear allowance will be abolished from tax year 2016/17.
In addition to the above, capital allowances for a property business are given on equipment used for the repair or management of a property, or equipment let as part of the building. Equipment costs can be deducted in full provided the total costs are within the annual investment allowance (of £25,000 for 2012-13.)
Landlord's Energy Savings Allowance
Although most items of capital expenditure are not tax deductible, there are certain exceptions. The landlord energy savings allowance is available for improvements which make a home more energy efficient. The allowance is available for draft proofing, cavity wall, loft and floor insulation. Tax relief is available for up to £1,500 of eligible expenditure per dwelling, per year. The allowance is scheduled to continue until 5 April 2015.
Mortgage arrangement and legal fees
Mortgage arrangement fees are deducted from rental profits in the tax year in which they are paid, rather than the tax year in which they are arranged. Therefore, an arrangement fee added to the loan value would be deducted from profits over the life of the loan. By contrast, mortgage arrangement fees which are paid up front will be deducted in the same tax year of the payment.
Most conveyance fees are not deductible from rental profits. Legal fees of this nature are added to the cost of acquisition and cost of sale when calculating taxable gains on eventual disposal of a property.
Legal fees for the acquisition of a short lease are not tax deductible, whereas fees regarding the renewal of a short lease can be deducted from taxable profits.
Legal costs related to letting agreements can only be deducted from taxable profits where the tenancy is for one year or less. Legal fees relating to evicting a tenant are tax deductible.
Accountancy fees for the preparation of business accounts are allowable, but for the preparation of a personal tax return are not allowable. Accountancy fees relating to a tax enquiry are not generally allowed, unless the fees relate to rental income and no taxable profits result from the enquiry.
Most types of insurance related to a rental business are allowable including building insurance, contents insurance and insurance to cover loss of rent. An insurance indemnity for lost rents will be treated as taxable income. Compensation for damages would reduce the repair costs that can be deducted from allowable expenses.
Only expenses which are wholly and exclusively for the rental property business are allowable. Administration costs as a landlord may be deducted against rental profits. These are likely to be higher if a letting agent is not used. Typical expenditure may include telephone and office costs.
There are no capital allowances for cars in a rental business. Therefore motor expenses for business journeys are typically allowed for through the mileage allowance (of 45 pence per mile for 2012-13.)
Various costs, provided these are not borne by the tenant related to the rental business can be deducted from tax adjusted profits. Examples of the expenses would include: Letting agent fees, light and heating costs, gas safety and other compliance costs, service charges, ground rent, cleaning, maintenance, gardening, and advertising costs.
Below market rent
Where a property is let at a nominal rent, expenses incurred on that property are only allowed up to the amount of the rental income.
Where a part of a property is made available for letting, expenses relating to that proportion are deductible. However, landlords who let their only or main residence can choose either to deduct a proportion of the expenses, or to deduct a flat amount of £4,250 from their profits. If the election is made to deduct £4,250, this amount cannot be more than gross rents, and therefore cannot create a loss. The 'rent-a-room' scheme can be chosen for any tax year. It is therefore worthwhile to switch between normal and rent-a-room basis depending on whichever is most favourable from a tax perspective.
Furnished holiday letting
Income from the commercial letting of furnished holiday accommodation in the UK (or European Economic Area, EEA) is treated for most tax purposes as if it were trading income. Broadly, the accommodation must be available for 210 days and let for 105 days. The property must not be available for long term letting for more than 155 days per year. Property let for a period of more than 31 continuous days will be treated as let on a long term basis.
There are tax advantages to furnished holiday lettings which are not available to other letting businesses.
- The profits are treated as earnings for the purposes of determining the maximum amount that can be contributed towards a pension.
- Entrepreneur's' relief would be available to reduce any gain, and Business Roll Over relief and Hold Over relief would be available to delay tax on any gain brought about by disposing in property which is classified as furnished holiday letting.
- Capital allowances are available on furniture, fittings and white goods in the property. However there is no 10% wear and tear available.
- Unlike trading income, there is no national insurance on profits.
A loss on a UK furnished holiday letting business can be relieved against future profits from the same UK business. If the furnished holiday let is outside the UK and within the EEA, the loss on this business can only be relieved against future profits from the same EEA business.
Where land is acquired with the main object of realising a gain, the profits on disposal will be taxed as income.
Premiums for leases over fifty years are treated as a capital receipt. If a lease is short, i.e. less than fifty years, some of the premium may be treated as taxable income in the year of receipt. The amount treated as capital on a short lease is 2% of the premium for each year of the lease, minus one year. For a £50,000 premium on a 15 year lease, £14,000 would be treated as capital and £36,000 would be treated as income for the lessor in the year of grant. The amount treated as income in the hands of the lessee is also an expense in the hand of the lessee, only spread evenly through the term of the lease. In the above example the lessee could deduct £2,400 per year as a trading expense.
If a rental business makes a loss for a particular year then the loss is carried forward and set against the next available UK rental profits for the business. It is therefore useful to record a loss on the related Tax Return.
In the unlikely event that the rental business has a loss, and also makes a claim for capital allowances, the amount of capital allowances may be deducted from the taxpayer's general income for the year of the loss.
Coman & Co have specialist knowledge and experience in the field of property taxation. We would be pleased to discuss your requirements, whether you are a non-resident landlord, have a buy-to-let portfolio, are considering letting your former home, have a furnished property lettings business or any other related requirement. Please contact us for a free, initial consultation.