Becoming A Landlord – Prevent Tax Nightmares!

When first letting out a property or a room in your home, there are lots of things to think about, and it is quite likely that the tax implications are not at the top of the list. However, it is important that landlords understand their tax obligations, as mistakes and misunderstandings can prove costly. This article explores some of the tax and National Insurance contributions implications of letting property or a room in the UK.

From a tax perspective, all lets are not equal, and different rules apply depending on whether you let out a room in your own home, an unfurnished property, a furnished property or a holiday let.

The simplest case is letting a room in your own home. Under the rent-a-room scheme it is possible to receive rental income of up to £4,250 a year free of tax. This limit is increased to £7,500 from the tax year 2016/17. Where rental income is below this limit, you do not have to do anything. If it is more than this, you will need to tell HMRC and pay tax on the profit. The rent-a-room scheme is optional. If it is more beneficial, you can work out the actual profit (or loss) and pay tax by reference to that.

Where a property is let furnished or unfurnished, tax is payable on the rental profit. This is the rent received less allowable deductions for revenue expenses, such as letting fees, insurance, maintenance, cleaning, advertising, etc. The rules for calculating the profits for a furnished and unfurnished property are broadly the same, with the exception of the wear and tear allowance, which is available for 2015/16 and earlier years in respect of furnished residential lettings. The deduction is 10% of net rents, and is designed to cover the cost of replacing fixtures and furnishings. It is available regardless of whether any actual replacements took place in the year. The wear and tear allowance is replaced with a deduction for actual replacements from 2016/17 onwards. This will be available to landlords of unfurnished lettings as well as those letting furnished properties.

Special rules apply to properties which pass the tests for a furnished holiday let. To qualify as a furnished holiday let, the property must meet conditions as to occupancy, availability and actual letting. Landlords of furnished holiday lettings qualify for capital gains tax (CGT) reliefs available to traders, and plant and machinery capital allowances. 

A person may become a landlord by letting out their existing home (e.g. during a period when they work abroad or in another area of the UK); they may retain their existing property as an investment when buying a new home, or may buy an investment property.

There are some advantages to letting a property which has at some point been your only or main residence. When the property is sold, part of the gain will be sheltered by private residence relief, and the gain attributable to the last 18 months of ownership will be exempt. The chargeable gain may be further reduced by lettings relief.

When buying an investment property, as with any other property purchase, stamp duty land tax is payable on the purchase. 

For tax purposes, it is not necessary to compute and declare separately the profits for each let property. Tax is instead charged on the profits of the rental business as a whole. The rental business comprises all rental income derived by the same person or persons from letting land and property in the UK. The main exception to this is furnished holiday lettings, which form a separate furnished holiday lettings business. This means that where a landlord has more than one let (excluding any furnished holiday lettings), the rental income and expenses are essentially ‘lumped’ together, and the taxable profit computed by reference to rental income and expenses for all properties.

Losses from property business are of limited use, as they can generally only be carried forward and set against future profits of the same property rental business. The same is now true of lettings from a furnished holiday business. 

Many landlords fund the purchase of a buy-to-let property by means of a mortgage. The rules on interest relief are complex and, as announced at the summer 2015 Budget, the relief is to be gradually restricted from 2017/18 onwards.

Relief is available for the interest on borrowings up to the value of the property when it is first let. The borrowings do not have to be secured on the let property. No relief is available for the capital repayment element of any mortgage repayments.

At present, relief is given at the landlord’s marginal rate of tax, so basic rate taxpayers receive relief at 20%, higher rate taxpayers receive relief at 40% and additional rate taxpayers at 45%. However, from 2017/18 the relief is gradually restricted, such that from 2020/21 relief is given as a basic rate income tax reduction. 

CGT is payable on a gain on the eventual sale of the property, to the extent that it exceeds the landlord’s available annual exempt amount. Spouses and civil partners each have their own annual exempt amount, so where property is not already owned jointly, transferring it into joint names prior to sale (on a ‘no gain/no loss’ basis) allows a couple to make maximum use of their available annual exempt amounts.

If the property has at any time been the landlord’s only or main residence, private residence relief will shelter part of the gain. The last 18 months will also be CGT-free. The gain may be further reduced by lettings relief.

For most landlords, National Insurance contributions are not in point. However, where the landlord’s property management activities extend beyond merely operating as a landlord, Class 2 National Insurance contributions may be due, as for a self-employed earner. This may be the case where the landlord has multiple properties, is actively looking to acquire more properties and the letting of property is the landlord’s main occupation. However, where a person has one or two buy-to-let properties as an investment, National Insurance contributions should not be payable.

When you first start renting out a property, you need to tell HMRC. If you expect your rental income to be less than £10,000 a year and your rental profit to be less than £2,500 a year, you can simply call HMRC’s self-assessment helpline (on 0300 200 3310) to let them know. If your expected rental income is more than £10,000, or your profit is more than £2,500, you will need to register for self-assessment if you haven’t already (for which see www.gov.uk/log-in-register-hmrc-online-services/register). It is advisable to register as soon as possible, but in any event by 5 October after the end of the tax year in which you become a landlord.

Property income is declared on the property pages of the self-assessment tax return. You may be able to arrange with HMRC for tax on your rental income to be collected via your PAYE code if you are also employed, rather than paying it under the self-assessment system. Tax is due by 31 January after the end of the tax year. Where the total tax owed under self-assessment is £1,000 or more, payments on account must be made on 31 January in the tax year and on 31 January after the tax year, with any balance payable by the following 31 January.

To work out your rental profit, you will need to keep records of all your rental income and your expenses. It is advisable to set up a proper record keeping system from the start, as this will save headaches later on.

There is a lot to organise when becoming a landlord. Taking advice on the tax implications from an accountant or tax adviser can save time, and ensure that you stay the right side of HMRC.