Simple Guide to Tax
Here at RITA4Rent, the question we are faced with time and time again is: "I have just become a landlord. Where do I start with my taxes?"
As has been proved by HM Revenue and Customs' Let Property Campaign, a scheme targeting those not declaring rental profits, there is quite a serious issue in that a lot of landlords do not understand their taxation obligations. It has previously been reported that 1 in 3 landlords did not declare their rental profits, highlighting the need for greater landlord education and awareness in the self assessment tax system.
Whether you have purchased an investment property, or inherited a property which is now let to tenants, or even let your previous home to tenants, you must consider your tax implications and determine how and if this should be reported. For most landlords, you will need to submit a self assessment tax return.
A self assessment tax return is a form which is submitted to H M Revenue and Customs (HMRC). This can be completed either in traditional paper format or on line. The tax return serves the purpose to report all your taxable income (as well as your rental income and expenditure), and to then determine whether you have paid enough tax during the year, or alternatively, if you have paid too much tax.
Please note importantly, that you are taxed on rental profits not rental income. Taxable profits are calculated by deducting allowable expenditure from your rental income received. If your taxable profits are over £2,500, or your rental income before deducting expenses is in excess of £10,000, then most landlords need to report this on their self assessment tax return. Should the property be jointly owned, then your share of rental income and expenditure would be reported on your own tax return. The joint owner of the property would therefore report their share separately if they are required to do so.
Once you have ascertained that you need to submit a tax return, you must register with HMRC confirming you are in receipt of rental income. You should register for self assessment by 5 October following the first tax year end date where the rental income was first received. A tax year is different from a calendar year, and HMRC operate on a tax year basis. A tax year runs from 6th April one year, to the 5th April the following year. For instance, if letting commenced in December 2014, this would be referred to as the 2014/15 tax year, which runs from 6th April 2014 to 5th April 2015.
Registration can be completed either on line, or by filling out and posting an SA1 form, which is available on the HMRC website. Once you have completed the registration process for self-assessment, HMRC will issue you with a Unique Taxpayer Reference number, often referred to as a UTR number.
The tax year ends on 5th April each year, and once ended, the two main deadlines to remember are:
- 31 October - Final due date to file your self assessment tax return (paper method)
- 31 January - Final due date to file your self assessment tax return (online submission)
Should you calculate that tax is owing when completing your self assessment tax return, this must also be paid by 31st January. Penalties for filing and paying late are harsh, and it is therefore of great importance to ensure you complete matters in a timely manner.
If you owe tax of less than £3,000, and you are in receipt of PAYE income, such as a pension or a salary, you may be able spread the cost over 12 months by adding the liability to your tax code. To benefit from this, your tax return must be filed by 30th December, rather than the usual 31st January on line tax deadline. If however on completing your tax return, you calculate a refund owing, you may choose to have the repayment sent out to you by cheque, or there is the option to enter your bank details, so that the refund may be paid electronically.
One other consideration as far as payments are concerned, is that if you owe over £1,000, you may need to make additional "payments on account." These are payments towards potential tax owed in the following tax year under self assessment. As an example, if when you prepare your 2014/15 tax return you ascertain that payments on account will fall due, as well as the tax liability owed under self assessment, additional payments on account will fall due on 31st January 201 6 and 31st July 201 6. There are some circumstances where payments on account do not fall due if you owe over £1,000. One main reason is if more than 80% of the tax arising under self assessment is covered by tax deducted at source (such as from your pension or employment income). Other reasons include the fact that capital gains tax and student loans are not included in the payment on account calculation.
With regards your let property, you will need to fill in the income from property pages of the self assessment tax return. There are two pages with numerous boxes to be filled in. Please note however that not all of these will be applicable to your circumstances. Also note that your standard rental income and expenditure is reported separately to any income and expenditure relating to a Furnished Holiday Let, if this is applicable to you.
If you have more than one property, all the income should be pooled together, with the total figures entered on the tax return. If this is applicable to you, then you also need to enter on your tax return how many properties you are reporting on.
There are numerous expenses which may be claimed against rental income, which can reduce the amount of tax owed. Expenses are classified and grouped under particular headings, with the total amounts entered in the relevant boxes of the income from property pages.
Typical expenses which may be claimable against your rental income are: ground rent, service charges, council tax, water and utility bills, cleaning and gardening costs, buildings and contents insurance, repairs and renewals of the property, tax advice fees, letting agents' management fees, advertising costs, certain legal fees such as renewing a lease for less than 50 years, course fees and training costs of a revenue nature, membership of a landlord association such as the Residential Landlords Association, trade subscriptions and professional books, motor expenses such as mileage, reasonable hotels and subsistence for business trips, telephone costs, stationery and postage costs and certain pre letting expenses. Following the July 2015 budget, mortgage interest and finance costs may only be claimed as an expense up until 5th April 2017. From 6th April 2017 onwards, a four year equal "phase in" will restrict this relief, resulting in only a 20% basic rate claim being possible by 2020.
One complex and detailed area included in the above is repair costs. In this area, costs fall in to either the revenue classification or capital. Revenue costs may be claimed against your rental income, whereas capital costs must be retained instead for future use against a potential capital gain when the property is sold. As an example, if a bathroom was painted, generally this could be claimed as an allowable cost against rental income on your tax return. However, if you built an extension which housed a new bathroom, this would be deemed a capital cost. As such, it cannot be claimed against rental income, and instead retained for future use against a potential capital gain on property sale.
Another worthwhile mention is the wear and tear allowance. This may only be claimed if your property is let fully furnished. To be classed as fully furnished, HMRC state that there must be sufficient furniture for the tenant to benefit from normal occupation. We would take this guidance definition to mean a tenant can just move in to the property and need only bring with them a suitcase of belongings.
When preparing your tax return, wear and Tear allowance is calculated as 10% of the net rent received. If the property being let is not fully furnished, then the wear and tear allowance may not be claimed. Please note, this allowance is being removed from 6th April 2016 onwards, as announced in the July 2015 Budget.
We highly recommend that all landlords keep complete and accurate records. This could be by way of a spreadsheet such as the RITA Property Accounts spreadsheet or a suitable software package. Accurate record keeping helps keep matters simpler when you prepare your tax return each year, and also helps you keep a track of income and expenditure for your own planning needs. In addition, should HMRC enquire into our tax affairs, keeping complete and accurate records will help facilitate the overall process. One other important reason to keep accurate and adequate records is that during the lifecycle of the lettings business, you may incur capital costs. As highlighted previously, these are costs which may be claimed against capital gains, reducing the tax payable.
If you sell your let property, this is the point at which a potential capital gain may arise. Please note that the sale date per your tax return is not the completion date, but instead, the date contracts are exchanged.
A capital gain is calculated by deducting the purchase cost and any other allowances and costs, from the proceeds of sale. Allowable costs you may claim against a capital gain include solicitors' fees, stamp duty, estate agent commission, and capital improvements to the property. Capital gains are usually chargeable to tax at the rate of either 18% or 28% depending on the level of your other taxable income. In addition, taxpayers currently have an £11,100 annual exemption, which is the gain which may arise, where tax would not fall due. The excess would then be charged as previously stated. Further reliefs may be available, one example being if the property used to be your main residence. If a capital loss is generated on sale, it is important to register this, so as to benefit from this in the future.
If you are in any doubt with your personal tax position and obligations, or require specialist landlord tax advice, please visit the RLA's Tax Centre.