Income Tax when you rent out a property: case studies
Examples to help landlords avoid common mistakes when working out and reporting income and profit from renting out a property.
The examples here are designed to support the main Income Tax guidance for landlords. They deal with a range of tax issues that you may need to think about if you rent out a property.
Rate of tax
The rate of tax you’ll pay on rental income depends on your total income for the year, eg from wages or a pension.
Find out about the current Income Tax rates and personal allowances.
This example explains how tax on Raj’s rental profit is worked out.
Raj received £12,240 rental income in the 2013 to 2014 tax year. He has £1,500 allowable expenses in the 2013 to 2014 tax year, and he received no other income in the year.
Step 1 - calculating the net rental profit
To work out how much tax he needs to pay, Raj first needs to deduct his allowable expenses from his rental income.
|Minus allowable rental expenses||£1,500|
Step 2 - deducting the personal allowance
Raj then deducts his personal allowance (the amount he earns before tax is due) for the year.
Raj is entitled to a personal allowance of £9,440 for the 2013 to 2014 tax year. As Raj has no other income, he can use the full allowance for his rental income in this tax year.
|Minus the year’s personal allowance||£9,440|
|Total taxable rental profit||£1,300|
Step 3 - working out the correct rate of tax
For the 2013 to 2014 tax year, the first £32,010 of taxable income, after the personal allowance has been deducted, is charged at 20%. This applies to Raj, as his taxable rental profit is £1,300.
|Total taxable rental profit||£1,300|
|20% basic rate Income Tax||£260|
|Tax due on rental profit||£260|
Income from wages
If Raj had been in employment during the year, he would have been liable to pay tax on his total earnings from his Pay As You Earn (PAYE) employment and his rental profit minus his personal allowance for the year.
Raj will already have paid tax on his wages, but he will need to show this on an employment page on his Self Assessment tax return, or the amount of tax he owes will not be worked out correctly.
Increasing a mortgage
The rules are slightly different and more complex if you’ve remortgaged against the value of your rental property.
If you increase your mortgage loan on your buy-to-let property you can also treat interest on the additional loan as a revenue expense but only up to the capital value of the property when it was brought into your letting business.
Interest on any additional borrowing above the capital value of the property when it was brought into your letting business is not tax deductible.
You purchased a buy-to-let property for £120,000 with a mortgage of £90,000 and let it to a tenant straight away.
3 years later the property is valued at £150,000 and you increase your mortgage on the property to £115,000. All of the interest on the mortgage can still be claimed as a revenue expense as the loan doesn’t exceed the initial £120,000 value of the property when it was introduced to your letting business.
If you increased the mortgage to £125,000, the interest payable on the additional £5,000 is not tax deductible and cannot be claimed as a revenue expense.
Expenses incurred wholly and exclusively for the property rental business
You can sometimes offset any costs - or ‘expenses’ - of keeping your rental property against the rental income, which could mean that your taxable rental income is less.
However, the expense should be incurred wholly and exclusively for the purposes of your property rental business. This means that if an expense was not incurred for the purpose of your property rental business, in any way at all, then you can’t offset the cost against the rental income.
If you buy a new vacuum cleaner for your own home, and also use it to clean your rental property between tenants, you can’t claim the cost of the vacuum cleaner as an expense against your rental income.
However, you could claim the cost of any cleaning products you bought specifically for cleaning the rental property.
Where costs are incurred partly for your rental business and partly for some other purpose you may be able to claim a proportion of that cost if that part can be separately identified as being incurred wholly and exclusively for the purposes of the property rental business. More information on this is in the next section.
Claiming part expenses
Sometimes you may incur a cost that is not ‘wholly and exclusively’ incurred for your property rental business, but a proportion of it is. Where a definite part or proportion of an expense is incurred wholly and exclusively for the purposes of the property business, you can deduct that part or proportion.
Tom has an investment property, and he decides to replace the tiles in the bathroom. His local tile shop has an offer of 12 square metres of tiles for £240.
He only needs 8 square metres for the bathroom, but the offer is excellent value for the money and too good to miss. He therefore purchases the tiles.
He decides to use the extra 4 square metres of tiles for his own house.
This means that the entire cost has not been incurred wholly and exclusively for the rental property.
However, a portion of the cost - two thirds, in fact - has been incurred wholly and exclusively for the property.
He can therefore claim £160 (ie, two thirds of £240) against his rental income.
Typical maintenance/repair costs
These are typical maintenance or repair costs that you are likely to incur, and which you can claim against your rental income:
- repairing water/gas leaks, burst pipes
- repairing electrical faults
- replacing broken windows, doors, gutters, roof slates/tiles
- repairing internal/external walls, roofs, floors
- repainting and redecorating (but not improving) the property to restore it to its original condition
- treating damp or rot
- re-pointing, stone cleaning
- hiring equipment to carry out necessary repair work
- replacing existing fixtures and fittings, such as radiators, boilers, water tanks, bathroom suites, and kitchens, but not electrical/gas appliances
John is informed by his tenants that water is leaking from the upstairs bathroom into the downstairs living room. He calls a plumber to repair the damaged bathroom water pipe and also hires a painter/decorator to re-decorate the damaged ceiling.
The entire cost of the work is £300 and it can be claimed against the rental income. The painting and decorating was done to restore the damaged ceiling, not to improve it.
Replacement of Domestic Items Relief - calculating the amount of deduction
The amount that you can claim as a deduction for a new replacement item is:
- the cost of the new replacement item, limited to the cost of an equivalent item if it represents an improvement on the old item (beyond the reasonable modern equivalent) plus
- the incidental costs of disposing of the old item or acquiring the replacement less
- any amounts received on disposal of the old item
David has replaced a single, wooden framed bed in his rental property with a new double divan bed. The new double bed is an improvement on the old bed and David paid £500 for it which is significantly more than the £150 it would have cost if he had replaced the old bed with a new equivalent wooden framed bed. Therefore David cannot claim more than £150 of the purchase cost as a deduction. David also paid an additional £20 to have the new bed delivered but managed to sell the old bed online for £30.
David needs to work out how much he can claim as a deduction:
|Cost of new replacement item (limited to the cost of an equivalent new item)||£150|
|Plus any costs associated with the buying the new replacement item (in this case delivery charges)||£20|
|Minus any amounts received on disposal of the old item (in this case selling the old bed)||£30|
|Amount deductible under Replacement of Domestic Items Relief||£140|
Calculating a profit or loss for more than one property
If you are renting out more than one property, the income and expenditure from all properties are combined to determine an overall profit or loss for the year.
Example 1 - overall profit
Carol has 5 properties in the UK. The following rental income is received and expenses incurred in relation to each of the properties in a single tax year.
Properties 3 and 4 made a loss in the year. However, the rental business is treated as a whole. Relief for these losses is given automatically against the profits made by properties 1, 2 and 5. The rental business as a whole makes a profit of £10,500 and Carol will pay tax on this total profit. Carol does not need to claim relief for the losses on individual properties as all the properties are combined to form a single property business.
Example 2 - Overall loss
Louis has 2 flats in the UK that he rents out. In the year to 5 April he receives rental income and incurs expenses in relation to the flats as follows:
Although the loss from property 1 is partly offset against the profit on property 2, the rental business as a whole makes a loss of £4,500. This loss is carried forward and offset against any future profits.
Carrying forward losses
If you make an overall loss, you can offset that loss against any profits that arise from the same rental business in the future.
However, you can’t offset losses from one rental property business against profits from a different business. For example:
- losses from a UK furnished holiday lettings business are only available to set against profits from a UK furnished holiday lettings business
- losses from an EEA (European Economic Area) qualifying furnished holiday lettings business would only be available to set against profits from an EEA furnished holiday lettings business
Example 3 - losses and profits
Richard has a property rental business. He makes a loss of £20,000 in year 1, a profit of £3,000 in year 2 and a profit of £32,000 in year 3.
|Year||Profit/loss||Loss brought forward available for offset against profit||Amount of loss left available to carry forward||Adjusted profit figure after carry forward|
The loss of £20,000 in year 1 is carried forward and set against the £3,000 profit in year 2, reducing that profit to nil .
The balance of the loss of £17,000 is carried forward to year 3 and offset against the £32,000 profit in that year.
This will reduce the year 3 taxable profit to £15,000.
Richard must pay tax on the £15,000 profit.
If you let out a property on terms that are not commercial, eg, to a friend or a relative for a reduced rent, expenses incurred can only be deducted up to the amount of the rent received for that property.
This means that you don’t make a profit or a loss. Any excess expenses can’t be used in a later tax year, even if you later start charging an ordinary commercial rent in that tax year.
John lets his flat to his brother. The commercial rent for the flat is £600 per month but John only charges his brother £300 per month, which comes to £3,600 for the year.
During the same year John’s expenses for the flat were £4,000 and so were more than the rent received.
John can deduct expenses from his rental income but only up to the value of the rent he received, which is £3,600.
This reduces John’s profit to nil.
The £400 expenses that are left can’t be carried forward for use against rental income in future years, and can’t be used against any rental income from other rental properties.
If John’s brother had lived in the flat rent free then John would not be able to claim any expenses at all for this property.
If a rental property is jointly-owned, the way in which the rental income is taxed will depend on the share of the property that each person owns.
Tax implications for jointly-owned property - but not by spouses/civil partner
Where you receive income from property in the UK, that income is taxed as part of the profits of your property rental business.
In a straightforward case where you own a property jointly with another person (eg, friends, business partners, parent and child or brother and sister) and the property is let out, your share of the rental profits or losses will usually be based on the share of the property you own. Unless you agree a different allocation - this is explained further below.
Alice and Lucy are friends and invest in a flat together. Alice owns 60% of the property and Lucy the remaining 40%.
The property is let out and in the tax year rental income is £8,400 and allowable expenses £4,600. This results in a profit of £3,800. The profit is shared as follows:
- Alice (60%): £2,280
- Lucy (40%): £1,520
Property jointly-owned by married couples or civil partners
There are special tax rules for jointly-owned property for married couples and civil partners who live together.
The tax rules say that income from jointly owned property must be split and taxed in equal shares (50:50).
If you own the property in unequal shares, the income from it can be apportioned based on those shares and taxed on that basis. You would need to demonstrate and provide proof that you are entitled to receive income generated from the property in unequal shares rather than split 50:50.
To notify HM Revenue and Customs (HMRC), you should complete the declaration of beneficial interests in joint property and income form.
Helen and Simon are married and own a property which they let out. Helen owns 75% of the property and is entitled to 75% of the income and Simon owns 25% and is entitled to the remaining income.
Assuming the profit from letting the property was £6,000, in the absence of a declaration, each would be taxed on £3,000 (ie, 50:50).
However, as Form 17 has been completed and accepted by HMRC, Helen will pay tax on £4,500 (75% share of £6,000) and Simon will pay tax on £1,500 (25% share of £6,000).