With so little returns available at the moment for investors in stocks and bonds people are turning to property as an alternative. If you like the idea of becoming a landlord this post will give you a brief overview of the tax implications of letting property.
Income tax is payable on the net profits calculated on all your income from property, and the rate is dependent on how much other income you receive in the tax year (what’s called your “marginal rate of tax”). Therefore if you are already a higher rate tax payer before taking into consideration your rental income or very close to that point you will have to pay tax at 40% on your profits. However if you have very little other income it may be that you will have to pay tax at only 20% or even less. Thankfully there is no national insurance to pay on top, unlike self-employment income.
The main expenses that are deductible from your rents are –
Mortgage interest – this is not the same as your mortgage payments unless you are on an interest only mortgage. It’s worth bearing in mind that a landlord can increase the amount borrowed on the property and withdraw some of the capital originally invested as long is the borrowing doesn’t exceed the original cost of the property.
Repairs – you need to be careful to distinguish repairs from so called capital expenditure which is not allowable against income tax but is for capital gains tax. The difference between the two is sometimes difficult to distinguish but broadly capital expenditure involves the improvement or creation of something new, for example the installation of central heating where that had been none before, or adding extra space by building an extension. If there was already central heating in the property however, replacing it with something newer and more efficient would be treated as repairs.
Wear & tear – if the property is let furnished you can chose to claim a flat rate allowance equal to 10% of the gross rents less any rates paid instead of the actual costs of renewing furniture and fittings.
Amy losses that arise cannot be set off against other sources of income and must be carried forward to be used against future rental profits.
Capital Gains Tax
Capital gains tax is payable on any profit or gain on the sale of a rental property. The main exemption is principle residence relief (PPR) which will apply if you have at some point during your ownership of the property lived in it. PPR is a complex subject and I’ll deal with it in detail in a later post but it is a very important relief as it can often reduce capital gains to nil. Other that PPR there is limited scope for reducing CGT liabilities on rental properties unless they are furnished holiday lettings.
Allowable costs that will reduce the profit or gain include the initial cost of the property, professional fees incurred in the purchase and sale of the property and any capital expenditure carried out (see above for the distinction between capital and repair expenditure). The gain will be charged at either 18% or 28% depending on your other income and after deducting any unused annual capital gains allowance which is currently £10,600 per individual.