This blog is for informative purposes. You can find out more on the GOV website here.

Rental income

Rental income is the rent you get from your tenants. This includes any payments for:

• the use of furniture
• charges for additional services you provide such as:
• cleaning of communal areas
• hot water heating
• repairs to the property

Any profit you make from renting out property must be taxed. The amount you pay is determined by:

• how much profit you make
• your personal circumstances

The Profit you’ll make is whatever is left of the rental income after deducting expenses and allowances you claim.

If you rent out more than one property, the profits and losses from those properties are added together to arrive at one figure of profit or loss for your property business. However, profits and losses from properties overseas must be kept separate from UK properties.

Types of Property Ownership

Joint Ownership

If you share ownership of a rental property, the amount of rental income that you’ll pay tax on depends on your share of the property. Your share of a jointly owned property business isn’t a separate business from any other properties you may own yourself.

Property jointly owned with spouse or civil partner

For married couples or civil partners living together, a property jointly owned usually is taxed in equal shares. If you own the property in unequal shares and are entitled to income in the same unequal shares, the income can be taxed on that basis. You both need to declare beneficial interests in joint property and income.

Property Jointly Owned Not With a Spouse of Civil Partner

If your property is jointly owned with someone other than a spouse or civil partner your share of rental profits or losses usually is based on the share of the property you own unless you agree a different allocation.

Record keeping

It’s important to keep accurate records of rent received and expenses incurred so you can work out the profit you’ll pay tax on.

Your records must separate your income from fully-furnished lettings and unfurnished or part-furnished lettings.

The records you should keep could include:

• rent books
• receipts
• invoices
• bank statements
• mileage logs (for journeys that are solely for your property business purposes)

You must keep records for at least 5 years after January 31 tax return deadline for each tax year.

HMRC can charge you a penalty if records aren’t accurate, complete or readable or if you don’t keep them for the required time. You’ll also get a penalty if you submit a tax return that’s inaccurate.

Changes to Tax Relief for Residential Property

From 6 April 2020 Income Tax relief on all residential property finance costs is restricted to the basic rate of income tax. This is who it affects…

• an individual UK resident who lets residential properties in the UK or overseas
• an individual non-UK resident who lets residential properties in the UK
• an individual who lets residential properties in partnership
• a trustee or beneficiary of trusts liable for Income Tax on residential property profits

All residential landlords with finance costa are affected, but only some will pay more tax.

Here’s who wont be affected…

• UK resident company
• non-UK resident companies
• landlord of Furnished Holiday Lettings

You’ll continue to receive relief for interest and other finance costs in the usual way.

Finance Costs Restricted

Finance costs restricted include interest on:

• mortgages
• loans – including loans to buy furnishings
• overdrafts

Other costs affected are:

• alternative finance returns
• fees and any other incidental costs for getting or repaying mortgages and loans
• discounts, premiums and disguised interest

If you take a loan for both residential and commercial properties, you’ll need to use a reasonable apportionment of the interest to work out your finance costs for the residential properties, as only the residential properties finance costs are restricted. This also applies if your loan was partly a self-employment trade ad partly for residential property.

Allowable Expenses

When calculating your taxable rental profit, you can deduct costs from your rental revenue as long as they are entirely and solely for the purpose of renting out the property. You can also claim expenses for the interest on a mortgage to buy a non-residential let property.

Other types of expenses you can deduct if you pay for them yourself are:

• general maintenance and repairs to the property, but not improvements (such as replacing a laminate kitchen worktop with a granite worktop)
• water rates, council tax, gas and electricity
• insurance, such as landlords’ policies for buildings, contents and public liability
• costs of services, including the wages of gardeners and cleaners
• letting agent fees and management fees
• legal fees for lets of a year or less, or for renewing a lease for less than 50 years
• accountant’s fees
• rents (if you’re sub-letting), ground rents and service charges
• direct costs such as phone calls, stationery and advertising for new tenants
• vehicle running costs (only the proportion used for your rental business) including mileage rate deductions for business motoring costs

Expenses you can’t claim a deduction for include:

• the full amount of your mortgage payment – only the interest element of your mortgage payment can be offset against your income
• private telephone calls – you can only claim for the cost of calls relating to your property rental business
• clothing – for example if you bought a suit to wear to a meeting relating to your property rental business, you cannot claim for the cost as wearing the suit is partly for your rental business and partly to keep you warm – no identifiable part is for your property rental business
• personal expenses – you cannot claim for any expense that was not incurred solely for your property rental business

Allowable expenses do not include ‘capital expenditure’ such as buying a property.

Claiming Part Expenses

Where only part of an expense is for your property rental business, you can deduct that part as long as it’s wholly and exclusively for the property business.

Increasing Your Mortgage

Allowable expenses include the costs of maintenance and repairs to the property (but not ‘capital’ improvements).

A repair restores an asset to its original condition, sometimes by replacing parts of it.

These can include:

• replacing roof tiles blown off by a storm
• replacing a broken-down boiler
• redecoration between tenants to restore the property to its original condition

Replacing a part of the property with the nearest modern equivalent is still a repair if the improvement is incidental to the repair, such as replacing a single-glazed window with a double-glazed window.

If you have an insurance policy that covers the cost of some repairs to your property, you can only claim the additional expenses that you incurred for repairs which the insurance pay-out did not cover.

This also applies if you keep your tenant’s deposit from a Tenancy Deposit Scheme to cover damages they’ve caused to the property. You can only claim expenses incurred for repairs in excess of the amount of the deposit that you kept.

You cannot claim the costs for replacing furnishings or equipment in a property. These are not allowable as costs of maintenance and repairs, but from 6 April 2016 they may qualify for Replacement Domestic Items Relief.

The costs of renewing fixtures such as baths, washbasins or toilets are normally allowable as they are considered repairs to the building, as long as they are a like-for-like replacement and not an improvement.

The cost of replacing small items, such as cutlery, crockery, cushions, bed linen and similar is also allowable. To qualify the items have to be:

• of low value
• have a short useful life
• need to be replaced regularly (almost annually)

Allowances

Property Allowance

if you claim property allowance, you can get up to £1000 a year tax-free property income.

If you let out residential property (a dwelling house) you may be able to claim a deduction for the cost of replacing domestic items such as:

• movable furniture for example beds, free-standing wardrobes
• furnishings for example curtains, linens, carpets, floor coverings
• household appliances for example televisions, fridges, freezers
• kitchenware for example crockery, cutlery

Replacement of domestic items relief is only available for expenses incurred from 6 April 2016 for Income Tax purposes.

You can claim this relief when:

• you carry on a property business that includes the letting of a dwelling-houses
• an old domestic item provided for use in the dwelling-house is replaced with the purchase of a new domestic item and
• it’s provided for the exclusive use of the lessee in that dwelling-house
• the old item must no longer be available for use by the lessee
• the expenditure on the new item must not be prohibited by the wholly and exclusive rule but would otherwise be prohibited by the capital expenditure rule
• capital allowances must not have been claimed for the expenditure on the new domestic item

You can’t claim relief if:

• you replace a domestic item in a property which qualifies as a Furnished Holiday Let – you will continue to be able to claim capital allowances on these items
• if you use the rent a room scheme
• for the initial cost of buying domestic items for a dwelling house

Replacement of domestic items relief can be claimed for dwelling houses that are:

• unfurnished
• part furnished
• fully furnished

When The New item is an Improvement on The Old Asset

If a new item is an improvement of an old one, like replacing an old sofa with a sofa bed. You can only claim a deduction for the cost of buying an item the same as the original. If a new sofa cost £400 but a sofa bed is £550, you can only claim the £400 as a deduction and no relief is available for the £150.

A new item is only an improvement when:

• it’s not the same or substantially the same as the old item
• the functionally has changed (for example from a sofa to a sofa bed)
• you upgrade the quality or material of the item (for example you upgrade from synthetic fabric carpets to woollen carpets)

If a replacement item is reasonably modern, for example a fridge is replaced for a more energy efficient, this isn’t an improvement and the full cost of the new item is eligible for relief.

How Do You Work Out Amount of Deduction?

When you replace domestic items, you may sell or part exchange the old item. This may result in incidental costs of disposing of the old item or buying the new item.

To work out the allowable deduction for the new item you should:

1. Add together the cost of the new replacement item* and any incidental costs for disposing of the old item or buying the replacement.

2. Deduct any amounts received on disposal of the old item.

*the cost of an equivalent item if it is an improvement on the old item.

Capital Expenditure

Expenses are ‘capital expenses’ if they will be used in the business over a longer period of time, such as when you:

• add something to the property that was not there before
• alter, improve or upgrade something that was existing
• include the purchase of furnishings and equipment for the property

Capital expenses aren’t allowed and can’t be claimed against your rental income but you should keep records of them as you might be able to set them against Capital Gains Tax if you sell the property in the future.

examples of capital expenses that wouldn’t be allowable include:

• adding an extension
• installing a security system if there was not one before
• replacing a kitchen with one of a higher specification

If you carry out work on a property before leasing or renting…

Some costs of work on a property before leasing or renting it will be capital expenses and thus not permissible. This includes if you purchased a home in a decrepit or run-down state and either paid a significantly discounted price for it or it was not fit for rental.

Any repairs done to make it fit for leasing are unlikely to be repair work. They will be capital improvements to the property. The expenditures of these works will not be deductible.

How to Work Out Your Taxable Profits

You should treat all your receipts and expenses as one business even if you’ve more than one UK property by:

• adding together all your rental income
• adding together all your allowable expenses
• take the expenses away from the income

The rate of tax you pay depends on your total income for the year, from employment, self-employment or pensions and any allowances you can claim.

How to Report Your Taxable Profits

You must contact HMRC if you have taxable profits from the property you rent.

If you have not told us about your property rental, you need to do so by 5 October following the tax year you had taxable rental profits.

If you do not usually send a tax return, you need to register for Self Assessment by 5 October following the tax year you had rental income. If you do not, you could be charged a penalty.

There are different ways to register if you’re:

• self-employer or sole trader
• not self-employed
• a member of a partnership 

You should allow enough time to complete the registration process so you can send your return by the deadline.

Losses

If your authorised costs exceed your rental income, you will incur a loss. Normally, you may only offset that loss against future profits from the same rental firm.

If more than one property is rented out, the revenue and expenses from all properties should be totaled to calculate the entire profit or loss for the year. This means that costs for one property can be deducted from revenue from another. If one property loses money, it is instantly compensated by earnings from another.

Uncommercial Lets

Only losses resulting from commercial letting are eligible for reimbursement. If you rent out a property on non-commercial terms, such as to a friend or family for a lower rate, you can only deduct expenditures up to the amount of the rent collected for such property. This means you do not make a profit or a loss.

Reporting Losses

If HMRC ask you to send a tax return you need to give details of your rental income and expenses even if you have made a loss in the year.

If You Stop Renting Property…

Any losses that have been carried forward are usually lost as they cannot be set against any other income.

You may be able to deduct previous property losses from any earnings from the new property. This is applicable if you stay in the same property business and begin renting again within three years. This is determined by the circumstances of each case.

You may have to pay Capital Gains Tax if you make a profit when you sell property that’s not your home.

Contact HUSA Accountants

Speak to a our team of professionals today if you need advice on rental income, capital expenses, self-assessment and tax returns.