On the face of it, working out how much tax you should pay as a landlord is a simple business with little or no wriggle room. You add up your rental income, deduct allowable expenses such as agents' fees and interest on your mortgage for the property or properties, and there you have your taxable income.
In practice, though, there are plenty of twists and turns which, depending on how you navigate them, could slice thousands off your tax bill. Before looking at some of the ways you can deflate your annual tax bill, it's worth stating two general rules that you should follow.
The first is that although you are not obliged to keep accounts for a UK property rental business (unless you are operating as a company), you must complete a tax return, including the UK Property pages (SA105), and submit it to HM Revenue & Customs. If your property is overseas, you should complete the Foreign Property pages. If you qualify for the Rent a Room Scheme, you may not need to complete a tax return.
The second is: Keep good records. If HMRC ever raises an enquiry into your tax affairs, they could ask for all supporting documents. If you have them, this will keep the time and the cost spent on the enquiry to a minimum.
Note, too, that rental income must be declared in the tax year in which it is due, even if you do not receive it in that tax year.
1. Claim for every allowable expense - see sidebar for examples. There isn't a definitive list of expenses that can be claimed, however, and you should beware claiming for 'capital' expenditure such as improvements or material alterations to the property. For example, converting a garage into a bedroom would be a cost to your rental business, but isn't allowed as an expense against income tax. If it's an enduring asset, it's considered capital expenditure, and these should be deducted instead from your capital gains when you sell. If you have bought something that you plan to use for your rental business and also outside the business, you should be allowed to apportion part of the cost to the rental business.
You can't claim for buying furniture or furnishings in order to let a property, but you can claim for repairs made prior to letting - see 3 below.
Ongoing repairs are allowed. "You can claim for the repair or renewal of fixtures that are integral to property (ie things you wouldn't take with you when selling the property), so replacing a bath or the cost of fixing the central heating system can be claimed. But you can't claim for replacing the bath with a jacuzzi, although you can claim for the cost of a new bath even if you buy a jacuzzi - you just can't claim for the improvement aspect," says Nimesh Shah, senior manager at accountant Blick Rothenberg.
So, for example, a chimney pot falls off and damages some roof tiles. You decide to replace the chimney, the smashed tiles and the whole roof. You can claim for the cost of the chimney and the broken tiles but not for the whole new roof, as that wasn't an essential repair. Instead, this can be deducted later as a capital expense when you come to sell the property.
Treating damp is an allowable expense. Replacing a tired old kitchen with a new one is also allowable, but you will run into problems if the replacement kitchen is of a much higher specification than the old one.
You can also deduct unpaid rent - where there is no realistic hope of payment. If the rent is subsequently paid, it must be included in the tax return for that year.
Use two questions to help you decide exactly which expenses you can claim for against income tax and which ones you can't. The questions are: Was this expense incurred wholly and exclusively for the rental business? And is this a capital expense - that is, a one-off cost that will improve the value of the property?
If you can answer yes to the first question, and no to the second, then you should be on safe ground.
All VAT paid on allowable expenses can be claimed.
2. If your property is furnished, you can claim an annual wear and tear allowance. This is 10 per cent of the net rent. Up to 6 April 2013, you could either claim for replacing individual items, or you could deduct the 10 per cent allowance. If you previously claimed renewals, you should now switch to a wear and tear basis. The net rent is gross rent less any items that would normally be paid by the tenant, for example, council tax or utility bills. So for most landlords net rent is gross rent. You can only claim wear and tear if the property is fully furnished, so it might be worth targeting this market rather than the unfurnished market. If your annual net rent is £30,000, you can chop £3,000 off your taxable income every year, saving a 45 per cent taxpayer £1,350. But remember when it's time to replace mattresses, cookers, fridges and so on, you cannot claim these costs. You can find out more about the rules here: http://www.hmrc.gov.uk/briefs/income-tax/brief0513.htm
3. Claim for expenses incurred getting a property ready for a letting as long as these relate to repairs and advertising. Collapsing ceilings, a broken boiler or non-functioning radiators can all be claimed, and what's more, they can be claimed for up to seven years previously: you should lump them all together and claim them as a cost on the first day of letting.
But you cannot claim for money you have spent to make a property lettable, unless it's an actual repair. For example, tenants who have come to view the property are insisting on a dishwasher, or your letting agent advises you that a central heating system is essential, so you arrange for these to be installed. You will have to bear the cost of the dishwasher and you should deduct the cost of the heating system when you eventually sell the property.
4. How you own the property can yield tax savings. If you own jointly with a spouse/civil partner, you can use their tax-free allowances and tax banding. The ownership doesn't have to be split 50:50. But note that however you fix it at the outset cannot be changed later. "Doing this could save income tax of up to £18,000 if you are a 45 per cent taxpayer and your spouse doesn't earn an income. And when you sell the property, if your spouse has no other capital gains to offset in that tax year against allowance (currently £10,900), you can save £3,000 in CGT," says Nimesh Shah.
5. Consider owning your rental property through a corporate structure. The gap between corporate tax rates and individual ones has widened over the years. Corporate tax is currently charged at 23 per cent, falling to 20 per cent in 2015. Compare that with the individual rate of up to 45 per cent and a capital gains tax rate of 28 per cent. In addition, companies can reduce their capital gains by applying an inflation allowance, says Mr Shah. There are complicating factors, though. For example, to take money out of a company structure, you might take a dividend payment, and this will give rise to a personal tax charge. In addition, you would have to complete annual accounts and there are the costs of running the company, too. New taxes which apply to residential properties worth £2m plus owned by a company do not apply if the property is let on a commercial basis - that is, to a third, unconnected party. However full exemption from those taxes won't be available until July 2013.
6. Ideally, your buy-to-let property will have a big fat, fairly new (if it's on a repayment basis) mortgage attached. That way, you can maximise the relief you get on interest payments. Capital repayments cannot be claimed against your rental income. You can get interest-only BTL mortgages.
Interest on further borrowings related to the property can also be claimed, even if the money is diverted elsewhere. You can, for example, use those new funds to pay off a mortgage elsewhere or on the property you live in, says Mr Shah. If you have a good track record with your lender, you should be able to borrow against any equity in your property but applications are ultimately considered on an individual basis. "We won't accept further borrowing applications that are intended for business purposes," says Myra Butterworth at the Nationwide.
7. Until 2015, you can claim an Energy Saving Allowance of up to £1,500 per residential property if you carry out work that will save energy, for example, insulating a hot water system or a loft. You can't claim it, though, for the Rent A Room scheme.
8. RENT A ROOM SCHEME
If you are renting out a room in a house that is your principal private residence (ie it's your home and you live there more than anywhere else), keep the rent from the room below £4,250 a year. That way, the income will be entirely tax-free. You can also split the rental income with your spouse/civil partner, or put it all in the name of the lowest earner.
