Rental income is the earnings made from the landlord's rent, and it also includes other costs that you pass on to your tenants. Also, you need to add any portion of your tenant's security deposit, which you hold at the end of the tenancy, to the rental income. However, you can deduct certain allowable expenses from the income you may spend on cleaning and maintenance charges for communal areas. Any such utility bill can be incorporated into the maintenance bills of the property.
Landlords with more than one property need to add the rents they receive from all their properties and deduct their expenses. It means that you can offset expenses from one property against rents from another.
How to avoid paying tax on rental income? You can't avoid paying tax on your income, but you can reduce your tax bills by claiming some expenses (tax relief) that come with renting out property.
Some of the allowable expenses for day-to-day maintenance are –
- Landlord insurance includes the insurance of buildings, contents and public liability.
- Expenses on stationery and phone calls used for property business.
- Letting / management fees and accountant fees.
- Ground rent and service charges may include the cleaning and gardening fees (paid by the landlord).
- The cost of posting ads for getting tenants.
How to calculate capital gains on rental property? If you sell your rental property, you will have to pay capital gains tax (CGT) on the rise in the property's value while you have owned it. CGT is charged at 18% for basic rate taxpayers and 28% for those taxed at the higher rate tax.
What is the Rental Income?
If you charged a rent of £750 a month and your tenant agreed to you getting £500 as a deposit to cover repairs for the damage they caused, you would need to declare your annual rental income as £9.5K, where you would be able to deduct the £500 for repairs expense.
Each tax year runs from 6 April until 5 April the subsequent year. Rental income received in the tax year up to 5 April 2020 would need to be included in the online tax return, which one must file by 31 January 2021. If you are a new landlord, who hasn't filed a tax return before, you will need to register for self-assessment by 5 October.
If you think you failed to inform about the rental income, you can make a voluntary disclosure through the government's Let Property Campaign. You will have to pay the penalty, but if you don't make a voluntary disclosure and HMRC finds out later, you could receive a higher penalty or face criminal prosecution. There are questionnaires to help you decide whether you need to disclose unpaid taxes under this scheme. If your tax structure is complex, you can hire an accountant.
Avoiding Capital Gains Tax on Property UK
Capital Gains Tax is charged on financial gains that one gets once the asset is sold. The total gain is deducted by subtracting the sale value from the original purchase value.
Market value is applied when you sell the property. For assets acquired before 31 March 1982, the market value as of this date applies.
It may also be possible to cut the costs of any modifications made to the property during ownership. Such costs may include advice received, general improvements and other legal and professional costs.
Once the total gain is calculated, the applied tax relief and tax-free allowances are deducted before calculating the CGT charge, using the appropriate rate.
If you sell the property after 27 October 2021, you pay your CGT bill within two months of your property sale completion (or disposal).
Assets liable for Capital Gains Tax include all forms of property (unless specifically exempt), certain gifts made, sale of assets acquired by inheritance, shares and assets transferred through a divorce, or civil partnerships that have been dissolved.
Tax on Rental Income UK Calculator
Anyone whose total rental income is more than £10K before expenses or £2.5K after expenses will need to file a tax return. If the rental income is less than £2.5K, you should contact HMRC, as they may collect your income through PAYE.
Suppose you have many properties and want to know how a tax on rental income is calculated, as in the case of multiple BTLs and business properties. In that case, you can hire an accountant or get an approximate idea of the total liability through the online rental income UK calculator. This is because capital gains are not considered when calculating the tax on your rental income.
How Is Rental Income Taxed?
For the 2021/2022 tax year ( up to 2025-26), the higher rate tax band (taxable income of £50,271 to £150,000) is 40%, and the additional rate taxpayer (taxable income of over £150,000) is 45%.
So if you earn £15K through renting, the first £12,570 is tax-free, and you pay for the remaining £2,430 up to 20%. Some rules are different in Scotland. Your rental income will be added to your annual salary to calculate the taxes if you have a full-time job.
Landlords are entitled to certain tax relief like insurance, property repairs and maintenance, council tax, water/electricity bills, legal bills, accounting fees, wages of hired help, ad costs and vehicle running costs. In addition, one can also claim some relief on interest on the mortgage used to buy the property.
Some expenses are not allowed, like a home improvement, phone bills, clothing, personal expenses and the full amount of your mortgage payments.
One should always keep the expenses bills to claim relief, as HMRC may ask for proof when you seek tax benefits under rental income for landlords.
Capital Gains Tax on Rental Property
In the UK, Capital Gains Tax for residential property is charged at the rate of 28 per cent (for higher rate or additional rate taxpayers and basic rate taxpayers, the limit is 18 per cent), where the total taxable gains and income are above the income tax basic rate band. For trustees and personal representatives of a deceased person, the rate is 28%.
For non-residential property and other assets, the rates are in the range of 10% - 20% for individuals.
When selling a non-publicly listed business, you can claim Entrepreneurs' Relief, where you pay 10% on the sale of a business or business shares.
How to Minimise Tax on Rental Income?
Some of the ways you can adopt to minimise tax on rental income are given below-
1. Joint Property / split the rent - You can consider putting your buy-to-let property into joint ownership, where landlords split the rent in the most tax-efficient ways.
2. Deduct municipal costs and other expenses - You can deduct municipal taxes from your rental income, including property tax, sewerage tax, etc. If landlords pay municipal taxes, they can claim a deduction. Also, you can get deductions for the void period when your buy-to-let property is empty.
3. Standard deductions - You can minimise tax on your rental income by claiming for the landlord expenses like cost incurred on travelling back to the property, the ad costs, safety certificate bills, bank charges and similar charges.
4. Semi Furnished/Fully Furnished Properties - Since April 2016, Replacement Domestic Items Relief allows landlords to claim the net replacement costs of items of furniture and fittings. Even if you have a single rental property, don't forget that a landlord can claim expenses for running their rental business and the costs of running a home office. The claim applies to a minimum of £4 per week, but you need to provide written evidence of the expense deductions.
Other charges like if you have borrowed from family or personal loan for rental business, you may claim some relief. If you made losses in the previous years, you could calculate the loss and carry the losses to the subsequent year's tax calculation.
If you plan to move into the buy-to-let home, you can avoid CGT, where you can claim PRR. Also, pay tax on time to avoid late penalties.
Tax on Overseas Property Rental Income
If you are a UK resident, then despite the property being located abroad, you will still be liable to pay capital gains tax if you make a gain on the sale of the property.
Suppose you are resident in the UK and get rental income from overseas property. In that case, you will be taxed by HMRC in the same way as if the property was located in the UK under the income tax rules, and as per the UK's property allowance, the first £1K of the income from a rental property is considered tax free.
How long do you have to keep the property to avoid capital gains tax?
You need to declare rental income to the HMRC before the deadline following the end of the tax year. The tax year begins on 6 April and ends on 5 April the subsequent year, but the deadline for online tax returns is not until 31 January the year after. From 2019, CGT is due within 30 days of selling your property. Landlords follow different tax exemption rules, such as renting out a room to a lodger or letting out a property in the UK while you live abroad.
The 2-out-of-five-year rule applies in certain cases where you must have lived in your home for two out of the last five years before the date of sale. However, the two years don't have to be consecutive, and you don't have to live there on the date of the sale. Even though you may be deemed a non-resident for income tax purposes, you are treated as temporarily non-resident for capital gains tax purposes for up to 5 years. Certain gains made during that time are counted in the tax year if you return to the UK within five years.
When do I start paying taxes?
If it is your first year of self-assessment, you need to register by 5 October after you collected rental income, and you must contact HMRC even if your rental income is less than £2,500 a year, and you must report it on a self-assessment tax return. If HMRC suspects a landlord has been deliberately avoiding tax, it can reclaim 20 years' worth of tax payments. They can also impose fines up to the total value of any unpaid tax and the underpaid tax.
How much tax do you pay on rental income?
The tax you pay will depend on how much profit you make and how much rental income you receive from other sources and your job, property allowance, a pension and others.
As per the income tax rate in the UK 2020-2021 - you get a personal allowance of up to £12,500, where you are taxed 0%. So over £12,501 up to £37,500 is taxed 20 per cent and higher than £37,501 – £150,000 need to pay 40% and the highest above £150K is 45%.
If your property business suffers a loss in a year, you can offset it against your future rental income. For example – if you made a £2K loss in 2019-20 and a profit of £5,000 in 2020-21, you could deduct the previous year's loss from your profit, so you would only pay tax on £3K.
What counts as rental income for landlords?
The rental income may include other costs that you pass on to your tenants, like cleaning and maintenance charges for communal areas or the utility bills, which are included in the rent. You also need to include any portion of your tenant's security deposit, which you retain at the end of the tenancy. However, you can deduct the costs like maintenance costs and cost of repairs as allowable expenses. In addition, you have to pay council tax, and you can deduct it from rental gains.
What Are the Rental Income Tax Rates?
If you were in the 20% tax bracket for your overall income, your rental income tax bill would be 20% of £12K – £2,400. But you receive 20% tax relief on your £10K mortgage interest payments – £2,000. So your total tax bill would be £400. You can deduct the maintenance costs and other fees and bills from rental earnings, like when you buy a property for the first time and post an ad for it; you can deduct the cost of advertisements.
Earlier, landlords could get relief on interest on a mortgage. It was an invaluable benefit, especially for landlords in the higher-taxpayer band. However, new rules phased in and are fully operational from April 2020, where you no longer get the tax relief on rental income. Instead, you will get a tax credit based on 20% of your mortgage interest payments. In addition, you will need to pay capital gains tax (CGT) on any secondary residential property you sell where the gain you make is above your tax-free allowance for the tax year. However, you may be able to claim a reduction in the tax if you have lived in the home as your main residence.
Since there are many other ways you can reduce the tax bill, you need to get advice from an accountant to know more.