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Taxation of Property Income

Income tax is payable in the UK on rental income from a second home or an investment property, even if you live abroad and the money is paid there. All rental income must be declared to the tax authorities (except for the Rent-a-Room scheme), whether you let a property for a few weeks to a friend or 52 weeks a year on a commercial basis. You must pay income tax on the net profits (after expenses) at your highest rate of income tax (if you pay higher rate income tax, tax is payable at 40 per cent).

Before buying property, a married couple should decide in whose name it will be registered in order to take advantage of personal allowances and lower tax bands (if applicable).

After personal allowances and expenses have been deducted, you may find that there’s little or no tax to pay on rental income.

Deductions

You’re permitted to make deductions from your income for expenses, which may include all or some of the following:

• Management and letting expenses, including inventory and tenancy agreement fees and advertising;

• Financial fees and loan interest payments;

• Repairs and maintenance to the building and fixtures (excluding improvements);

• Renewal costs for appliances and furnishings (unless wear and tear is being claimed);

• Security (such as a monitored alarm system);

• Cleaning and gardening;

• Council tax;

• Buildings, contents and other insurance;

• Accountant’s and book-keeping fees;

• Legal fees;

• Service charges and ground rent for an apartment;

• Bills for mains’ services;

• Miscellaneous expenses such as stationery, telephone calls, and travel expenses to and from the property, e.g. when collecting rent or carrying out inspections.

You aren’t permitted to claim capital costs such as the initial outlay on furniture and kitchen appliances. You should seek advice from an accountant to ensure that you’re claiming everything you’re entitled to.

If a property is let unfurnished, the cost of repairing or replacing fixtures and fittings is tax deductible. If a property is let furnished, you can claim on the ‘renewals basis’, where you claim for items that need to be replaced, or use an alternative method called the ‘wear and tear allowance’. This allows you to claim an annual depreciation equal to 10 per cent of the net rent (i.e. less council tax, water rates, etc.), which is usually more beneficial. Under the wear and tear allowance scheme, when items such as soft furnishings are replaced no additional claim is available against tax, as this has been covered by the 10 per cent allowance. However, you can still claim the cost of renewing or repairing fixtures that are an integral part of a building.

Whatever basis is chosen must be followed consistently; you cannot chop and change between the wear and tear method and the renewals allowance from year to year.

Furnished Holiday Lettings

The inland revenue has a special set of rules for property let as ‘furnished holiday lettings’. These are defined as properties that are let for at least 70 days (ten weeks) of the year, are available to let for 140 days (20 weeks) and aren’t let to the same person for more than 31 days in any period of seven months. You can offset the cost of a loan and the running costs (but not when you occupy it yourself) against your other income and if you make a loss, which is likely in the first few years, you can offset this against other income thus reducing your income tax bill. However, you must intend to make a profit in the future. Under the special rules you may also qualify for capital gains tax reliefs such as roll-over relief and retirement relief (ask your tax advisor or an Inland Revenue office for information).

Letting a Room

Homeowners can take in a lodger (i.e. someone who’s treated as a member of the family) under the ‘Rent-a-Room’ scheme, where the first £4,250 of rent is tax-free. However, it isn’t compulsory to take part in the scheme if it isn’t to your advantage and you can simply declare all your letting income and claim expenses and (where applicable) capital allowances in the normal way. Note that it’s important to check that your lease or mortgage lender allows you to take in lodgers. For more information see the Inland Revenue (IR) booklet Letting and your home (IR87).

Payment Procedure

If you’re a UK resident, tax on property income is paid on account twice a year on 1st January and 1st July, in the same way as those who are self-employed. If you’re a non-resident and don’t have a UK letting agent, income tax must be deducted from rental income by your tenant(s) and paid to the IR each quarter on 31st March, 30th June, 30th September and 31st December. If you have a UK letting agent you can apply to have your rental income (which must be over £100 a week) paid gross and pay tax annually in arrears. If an agent provides a full management service, you should apply to the Financial Intermediaries and Claims Office (FICO), Non-Resident Landlord (NRL) section of the IR to have your rental receipts paid gross of tax. Under the NRL scheme, this relieves the agent of the responsibility of deducting basic rate income tax at source from rental income.

The advantages of registration are that you pay your tax annually in arrears after deduction of your expenses and allowances (which helps your cash flow), and aren’t required to reclaim money from the IR. Note that if you change agents or tenants, you must re-register with FICO. More information is provided in a booklet, Non-resident landlords, their agents and tenants (IR140), or you can contact FICO (Non-Residents), St. John’s House, Merton Road, Bootle, Merseyside L69 9BB (0151-472 6208/9).

Landlords (including expatriate or foreign landlords) must complete an annual self-assessment tax return from April after letting commences. If applicable, the return is sent to the address given on the FICO application form, which should be a private address (preferably your UK accountant). If you don’t receive a return you must apply for one, as this isn’t accepted as an excuse not to file.

If you fail to file a return, your application to pay tax in arrears will be revoked by FICO and a penalty could be imposed.

Some accountants advise that you file a return even if you make a loss, as it could be offset against future tax.

The Inland Revenue (IR) also publishes a comprehensive guide to letting income, Taxation of Rents: A Guide to Property Income (IR150), available from tax offices. Further information and leaflets can be obtained from the IR (08459-000444, www.ir.gov.uk).

© Survival Books Limited 2005

“Buying, Selling & Letting Property” 2nd Edition, David Hampshire.
Reproduced with the permission of Survival Books Limited.

Further information on this topic can be found in “Buying, Selling & Letting Property” 2nd edition, by David Hampshire.

For extensive, annually updated information about buying, selling and letting property, you can purchase this book at www.survivalbooks.net

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