However you make your money, the chancellor demands his dues, and being a landlord is no exception. Income earned from a rental property is like income earned any other way, and as such, you need to pay tax on it.
If you’re used to handing over your hard-earned cash to HMRC via simpler methods like PAYE, then taxation for landlords might take a little bit of getting your head around. In essence, it’s a lot like being self-employed. How much tax you pay depends on how much you earn overall in the year, and you’re allowed to deduct various allowances and expenses from the taxable amount before you calculate how much you owe.
How much tax do I need to pay on my rental income
How much tax you pay will depend on your total income over the course of the year. This might include earned income from your job and rental income from your property, plus any additional monies like interest on bank accounts and investments, or profits from the sales of properties/shares/etc.
Some stuff is exempt, like a limited amount of savings interest and dividend income, income from tax-free accounts (including ISAs), and lottery/premium bond wins. The most significant tax-free allowance from a rental point of view is the ‘rent a room’ allowance. If you rent out furnished accommodation in your own home, then in the 2016/17 tax year, you’re allowed to take £7,500 in rent tax-free. You’ll owe tax on anything above this.
The percentage of your income that you pay to the government in tax will depend on what income band you’re in. We all start with a ‘personal allowance’ of up to £11,500, and you don’t start paying tax until your income tips over this magic amount. For income between £11,501 and £45,000, you’ll pay a basic tax rate of 20% on anything over the personal allowance. So if you made £16,500 a year, you’d have to pay 20% of £5,000, which would be £1,000.
Income above £45,000 a year is taxed at a higher rate of 40%, while income above £150,000 is taxed at 45% (and you don’t get a personal allowance above £123,000). If you’re making that much then you probably don’t need to be reading a concise guide to working out tax.
What might my expenses be?
Of course, the rental element of your income might not necessarily be the amount that the tenant transfers into your bank account each month. As all landlords know, there’s a big difference between rent and profit, and it’s mostly only the latter that you have to pay tax on.
If you use agents, then many of the deductions for fees and maintenance will take place before the money ever hits your account, but there are likely to be other things that need knocking off too.
If you own a leasehold property, then the various tithes, maintenance costs and management fees charged by your freeholder are all deductible. Same goes for any additional expenses incurred in the course of maintaining your flat. If you’ve shelled out for HMO (house in multiple occupation) licences, maintenance work or anything else, all of that is reducing your overall income.
What about wear and tear to the property?
Inevitably, stuff wears out, and under the old, pre-2016 system, landlords of fully furnished properties used to be able to deduct 10% from their taxable profits to put towards replacing knackered items.
The system has recently been revised, and in many ways it’s fairer and simpler. Nowadays you just knock off the cost of replacing the worn-out items, including any associated recycling or disposal costs. If you’ve sold the old item, even for a small amount, then you need to be honest about this.
The significant thing about the new rules is that you’re only allowed to replace items like-for-like (or at least with the closest modern equivalent). So while under the old rules you could use your 10% however you cared to, these days you can’t rip out a £200 free-standing electric cooker and replace it with a £2,000 dual fuel range. If you want to upgrade your property, you can’t use your wear-and-tear allowance to do it.
Can I expense my mortgage payments?
Landlords used to get ‘mortgage relief’ where they were allowed to deduct mortgage interest and other finance costs (like arrangement fees) from their profits before they worked out their tax, but this is being phased out, and the amount you can claim is decreasing each year. From April 2020, it’ll be gone altogether.
There’ll still be allowances made, in the form of a ‘reducer’. So once you’ve worked out how much tax you owe, you’re then allowed to deduct 20% of your annual mortgage interest from the final tax bill. Superficially, this looks as if it’s going to achieve much the same result as just paying basic rate tax under the old system, but actually it all depends on how hefty your mortgage interest is. Many landlords, particularly those with other earned income, will find themselves nudged up into the higher rate tax bracket, so they’ll be paying 40% but only getting a 20% reducer on the final bill.
The outlook for landlords
Fair or not, private landlords are a soft target. Successive budgets have usually found new ways to put the squeeze on them, whether through reducing mortgage relief or hiking stamp duty costs, and with little public sympathy, this looks set to continue.