It’s only a small word but it looms very large in the thoughts and the nightmares of many of us. It was Disraeli who said that there are only two things in life that are certain…., “death and taxes”. The good news is that you don’t have to be quite so fatalistic. Like anything in life, you can be a victim, or you can make circumstances work for you. It always helps if you have a good accountant to guide you.
I confess it is only belatedly that I’ve become acquainted with the intricacies of the taxation system. For years I managed without making a return. Not out of any deliberate plan to defraud. But just because I knew I wasn’t making any money. My mortgage payments were barely covered by the rental income and having not sold any property, there were no capital gains. So why trouble the poor overworked civil servants I thought!
Then house prices went through the roof! I sold a few properties and realised some capital gains, investing most of it back into property. It was only when talking to a tennis friend, who turned out to be an accountant that I started to think I might need to explore the matter a bit more carefully. A holiday to Australia in which I took along a copy of the Zurich Tax Handbook as a bit of ‘light reading’ convinced me that there might be a problem. I think it was the bit on ‘tax evasion’ being a criminal offence punishable by imprisonment that focused my thoughts. I resolved on my return to come clean. To my amazement, the tax system was not as penal or as complicated as I had feared. Now let’s look briefly at what the main taxes that affect a property investor are.
My Tax Liabilities
Tax liabilities for rental properties are assessed on the basis of income and capital gains. Firstly, let’s examine how liabilities derived from income are calculated.
All income from land and property in the UK is taxed under Schedule A; that includes residential investments whether they are furnished or not. Income and expenses for tax purposes are assessed as a single letting business. So effectively if you have one or one hundred properties, Her Majesty’s Revenue & Customs (HMRC) take the total figure rather than looking at individual properties. Income is assessed by tax years ending on the 5th April. Schedule A income is treated as investment income. As such any losses can only be carried forward and offset against Schedule A income and not personal income such as a salary.
Taxable profit is the income that remains after all allowable expenses have been deducted. It’s always helpful to have a quick flick through the ‘revenues’ booklet IR150 in Taxation of Rents for detailed guidance. Like everything these days a copy is available to download from their website
In essence, your taxable profit is calculated by taking your annual rent and then deducting expenses. For convenience HMRC separate expenses into 5 categories. These are:
Legal & professional- Legal services for a remortgage, valuation fees, mortgage broker fees, landlord safety certificate costs, tenancy agreement costs, letting agent fees, admin cost to close a mortgage, membership fees to a professional body
Repair, maintenance & renewals-redecoration costs, appliance repair charges, plumbing, electrical repairs, etc
Rent, rates, insurance, ground rents, etc -insurance, council tax charges, grounds rent
Cost of services provided, including wages – cleaning, meals
Other expenses -Telecom charges, utility bill costs, computer software, advertising costs, computer purchase (if used exclusively for the business – could be accounted as a capital allowance (see section on capital allowances below)
What are my allowable expenses?
Repair and renewals
Where a property is furnished or part furnished; rather than to claim as each renewal arises it is possible to make a single claim of 10% of rent as a ‘wear and tear’ allowance. This is accepted by the Revenue as broadly equivalent to the cost of normal renewals of furniture. Beyond the fittings, such as furniture there will be renewals and repair to the building e.g. repair to the roof, bathroom and windows, etc. This raises a real taxation hornet’s nest. When does a renewal become an improvement? The latter is not an allowable expense against income (although it can be offset against capital gains – see later under Capital Gains Tax( CGT)).
There is, as with many tax issues, a grey area of when a renewal becomes an improvement. It is largely a question of fact and degree in each case whether expenditure on a property leads to an improvement and therefore become a capital expense. UPVC windows were considered for many years to be an improvement and therefore the expenditure counted as capital. However, in recent years HMRC have relented and accepted that UPVC is for most people the modern equivalent of wood and therefore is considered a renewal.
Another example of the way the HMRC approach the subject is their approach to the refurbishment of a fitted kitchen. For example, they consider that where a kitchen is refurbished, including work such as stripping out and replacement of base units, wall units, sinks, etc, retiling, work top replacements, repair to floor coverings and associated re-plastering and re-wiring. Provided that the kitchen is replaced with a similar standard kitchen then this is a repair and the expenditure can be off set against income. If at the same time additional cabinets are fitted that increase the storage space, or extra equipment is installed; then this element is a capital addition and not allowable and the additional expense should be apportioned as a capital cost. If the standard units are replaced by expensive customised items using high quality materials, the whole expenditure is then judged to be capital.
Loans and Interest
Most people will have borrowed money to finance their investment. When accounting for these costs it is interest payments alone that are an allowable expense. This means where a loan is a repayment mortgage; only the interest element of the loan can be offset against rental income. It is also possible to offset other loans that have been taken out for the business. For instance, when one has been raised to finance a new kitchen or extension of the rental property. It should be quite clear in these cases that the loan is specifically for the business and where possible documentary evidence should be available (just in case the revenue raises an enquiry on the matter). Therefore, if a loan is arranged, try to separate it off from your personal finances. This could be done by using it to set up a separate business account.
Non – standard lettings
So far I have referred to the tax treatment of a ‘standard’ buy-to-let property rented on an Assured Shorthold Tenancy. There are two categories of residential rentals that are treated slightly differently by the Revenue. These are where somebody rents a room in their house and a furnished holiday let.
Rent a room
Under this system a person is allowed to rent out a room in their own home without having to pay tax providing the rent is no more than £4250 pa. If it is more than this, the taxpayer has the option to have the excess income (i.e. above £4250) taxed as a Schedule A rental profit. Otherwise the entire rent will be taxed in the usual way on the profit from the gross receipts minus allowable expenses.
Furnished holiday lettings
These are treated slightly differently to the Revenue from a standard residential let. This is because of the amount of management time involved and the relatively short rental periods. They are therefore are therefore classified as a business rather than an investment. Consequently a different tax treatment applies.
To qualify as a holiday let the following criteria must be met. The property must be:
* Available for holiday let at least 140 days a year
* Actually let for 70 days a year
* Not occupied by the same person for over 31 days in 7 months
The main advantage to landlords with a holiday let is that the activity is regarded as a trade and is assessed under Schedule D. Therefore, any losses can be offset against an individual’s personal income, which includes their salary.