Tax and mortgage issues
Before letting your property you will need to consider the effect on your mortgage, tax and the deposit paid to you. Below is some guidance regarding this.
Can I let my property if I have a mortgage or if I hold the property on a long lease?
If you do not own your property outright and do not have a buy-to-let mortgage, it is essential to get your mortgage lender’s agreement to let the property before you do so.
You should also check to ensure that your building’s insurance policy will provide cover whether or not the property is let or empty and make arrangements to extend the cover if it does not.
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What about my tax position?
You will be liable to pay tax on your gross income from rents but may be able to deduct some of your day to day running expenses for the property from them. Below we outline the basics to tax on residential lettings:
What counts as residential lettings?
If you have let out your property to people who use it as a home, then it counts as 'residential lettings'. (For tax purposes these are treated differently from furnished UK holiday lettings). Even if you rent out part of your own home, this can also count as residential lettings.
However, if you do rent out part of your home, you maybe able to take advantage of the 'Rent a Room' scheme instead. This lets you get tax-free income of up to £4,250 from letting rooms in your home.
What is ‘rent a room’?
The rent a room scheme can allow you to receive up to £4,250 (£2,125 if letting jointly) a year tax-free 'gross' income (receipts before expenses), if you have a lodger or are thinking about letting furnished rooms in your only or main home.
Who can take advantage of the scheme?
You can choose to take advantage of the scheme if you let furnished accommodation in your only or family home[*] to a lodger[†].
The scheme only applies if a lodger occupies a single room or an entire floor of your home. It does not apply if your home is converted into separate flats that you rent out or if you let unfurnished accommodation in your home. If you are planning to let out separate flats or unfurnished rooms, you will need to declare your rental income to HM Revenue & Customs (HMRC) and pay tax in the normal way.
Do you have to be a home owner?
No. You can also choose to take advantage of the scheme if you are renting your home. However, if you are renting, you should check whether your agreement allows you to take in a lodger.
Also, if you are a mortgage payer it's advisable to check whether taking in a lodger is within your mortgage lender's and insurer's terms and conditions.
If you share a home and both let a room(s)
If you are both letting furnished accommodation in your joint home, you will each be entitled to receive half of the allowance (up to £2,125 for the 2008-2009 tax year) without paying tax.
If you provide additional services
If you charge for additional services such as meals and laundry, you will need to add the payments you receive to the rent to work out the total receipts. If you get more than £4,250 a year in total, you will have to pay tax, regardless if the rent is less than that.
The advantages and disadvantages of the scheme
The Rent a Room scheme does not allow you to claim any expenses relating to the letting of the property (for example, wear and tear, insurance, repairs, heating and lighting).
Before joining the scheme you may wish to work out whether claiming £4,250 a year tax-free 'gross' income or declaring all of your letting income and claiming expenses on your tax return will provide a greater return. To be sure, compare the following:
m How much income you are left with after your expenses
· t The amount of your receipts (rent plus any income from laundry services, meals, etc) over £4,250 or £2,125 if letting jointly (2008-2009 tax year)
If you opt out of the scheme (or simply do nothing) you will pay income tax on the first amount. If you opt into the scheme you will pay tax on the second amount.
Before joining the scheme you may wish to work out whether claiming £4,250 a year tax-free 'gross' income or declaring all of your letting income and claiming expenses on your tax return will provide a greater return. To be sure, compare the following:
· how much income you are left with after your expenses
· the amount of your receipts (rent plus any income from laundry services, meals, etc) over £4,250 or £2,125 if letting jointly (2008-2009 tax year)
If you opt out of the scheme (or simply do nothing) you will pay income tax on the first amount. If you opt into the scheme you will pay tax on the second amount.
How to opt in or out of the scheme
If you want to opt in
· if you don't normally receive a tax return and your receipts are below the tax-free thresholds for the scheme, the tax exemption is automatic so you don't need to do anything
· if you wish to opt in and your receipts are above the tax-free threshold, you must tell your Tax Office - you can do this by completing a tax return and claiming the allowance
If you want to opt out
· just complete a tax return within the usual deadline and declare the relevant income and expenses on the property pages
Working out your taxable profits from residential lettings
Step one
You work out your 'net profit' as follows:
1. add up all your rental income
2. add up all your 'allowable expenses'
3. take your allowable expenses away from your income
If you have more than one residential letting, you group all the income and all the expense figures together.
Step two
To arrive at your taxable profit deduct any allowances you're entitled to from you net profit:
If you let furnished property, you can deduct either of:
· a 'wear and tear' allowance - based on a percentage of your rent
· a 'renewals' allowance - the cost of replacing old items with a new equivalent (but you deduct any money you get from selling the old item)
You may also be able to deduct certain 'capital' allowances for the cost of equipment relating more generally to your lettings business.
If you let out property you can work out your taxable profit (or loss) by deducting certain expenses and tax allowances from your rental income. Although, if you have several UK residential lettings you must combine the income and expenses to work out taxable profit.
Allowable expenses
The expenses you can deduct from letting income (unless it's under the Rent a Room scheme) include:
· letting agent's fees
· legal fees for lets of a year or less, or for renewing a lease for less than 50 years
· accountant's fees
· buildings and contents insurance
· interest on property loans
· maintenance and repairs to the property (but not improvements)
· utility bills (like gas, water, electricity)
· rent, ground rent, service charges
· Council Tax
· services you pay for, like cleaning or gardening
· other direct costs of letting the property, like phone calls, stationery, advertising
If your annual income from the letting is less than £15,000 (before you've taken off expenses) you include the total expenses on your tax return but if it's £15,000 plus you need to provide a breakdown.
Remember that you can only claim expenses that are solely for running your property letting business. If the expense is only partly for running your business (or if you use the property yourself) then you may only be able to claim part of it.
Non-allowable expenses
When you work out your profit, you can't deduct:
· 'capital' costs, like furniture or the property itself
· personal expenses - costs that aren't to do with your letting business
· any loss you make when you sell the property
But you may be able to claim some allowances instead.
Allowances that can reduce your taxable profit
There are different types of allowance you may be able to claim for your capital costs. Capital costs include expenditure you make on assets like furniture and machinery. The allowances you can claim for some of your capital costs vary according to the type of letting.
All letting properties
You can claim a capital allowance on the cost of things that you need for running any type of letting, like cleaning and gardening equipment. You can also claim for equipment that isn't for the use of a single let property, like a boiler that heats more than one property.
How much capital allowance can you claim?
The allowance depends on what you buy. You can usually claim 50 per cent of the cost, but sometimes you can claim 100 per cent for some environmentally friendly expenditure; each year after that you can claim 25 per cent of what's left. You'll get smaller allowances if you use the items privately or for anything other than your business.
The allowance is deducted along with other expenses in calculating your profits and HM Revenue & Customs (HMRC) can sometimes change the percentage, so you will need to check.
Which year do expenses belong to?
You have to allocate expenses to the year they apply to - it doesn't matter when you actually pay them. Sometimes you may have to allocate part of an expense to one year and part to another.
Losses
Normally, if your letting business makes a loss, you can carry it forward to a later year and offset it against your future profits from the same business.
Reporting your profits to your Tax Office
If your profit is less than £2,500
If you're employed, or getting a pension through Pay As You Earn (PAYE), and your taxable income from property is less than £2,500, your PAYE tax code can be adjusted to collect the tax on your property income each year. Just ask your Tax Office to send you the form P810 to report your income each year.
Contact details for your Tax Office are on your payslips or you can find them online.
If your profit is £2,500 or more or you're not on PAYE
You will need to fill in a Self Assessment tax return (contact your Tax Office).
If your total income from UK property is £15,000 or more in a tax year you must declare it on the land and property pages of the full Self Assessment tax return. If it's below £15,000 you may be able to complete a shorter four-page return.
When you fill in your tax return, put in the rents and expenses for the year they relate to - it doesn't matter when you actually receive and pay them (both types of returns have help notes).
For the quickest and simplest way to complete the full return, do it online - the figures you put in add up automatically and the filing deadlines are also more generous.
How much tax will you pay?
Your taxable profit from property letting is added to your overall income. If this is more than your tax allowances you'll pay tax using your normal Income Tax rates.
If you let property jointly
If you let property with someone else, when you fill in your tax returns, or forms P810, you should each show your share of:
· the income and expenses
· the profit (or loss)
The help notes for your tax return explain how to do this.
Paperwork that you need to keep
Keep records of your letting business for six years after the tax year they're for, whether you complete a tax return or not. You need them to back up the figures you put on your tax return. Your records should include details of:
· all the rent you receive and the dates when you let out the property
· any income from services provided to tenants
· your business expenses
· rent books, receipts, invoices and bank statements
What financial records do you need to keep?
The details you need will include details of your:
· rental income
· allowable expenses
· 'capital' costs
To back up your records keep rent books, receipts, invoices and bank statements.
Rental income
You'll need to keep a note of:
· the rent you charge and receive
· any services charged separately - for example meals, laundry service, etc
· the dates you rent out each property
Allowable expenses
Your records should include details of all your costs of letting or managing your property. Allowable expenses reduce your taxable profit. They include all or part of these costs:
· letting agent's, accountant's and legal fees
· buildings and contents insurance - only part if you just let part of the property
· property loan interest
· maintenance and repairs - not improvements
· utility bills, like gas, water, electricity
· rent, ground rent and service charges
· Council Tax
· advertising
· other direct costs of letting the property, like phone calls
Make sure that you can separate your business from your personal expenses.
'Capital' costs
You can reduce your taxable profit by claiming different types of allowances for the cost of furniture and equipment you provide with the property.
You may also be able to deduct certain 'capital' allowances for the cost of equipment relating more generally to your lettings business.
You'll need to log how much all of these things cost and when you bought them.
To back up your records keep rent books, receipts, invoices and bank statements. Also make sure that you can separate your business from your personal expenses.
Your Tax Office can ask to see your records at any time. So hold onto the detailed information even if your income's less than £15,000.
If you get rent under the Rent a Room scheme
If you use the Rent a Room scheme you don't have to keep a record of your expenses - you can't claim these under the scheme. But if your rent goes over the limit (£4,250) you can opt to pay tax on all of the rent after taking off your expenses instead. So it may be worth keeping a record of your income and expenses anyway.
Non-financial records
You'll also need to keep other records to show that your property's safe to let out.
For further details contact your nearest tax enquiry office or tax office or look at the HM Revenue and Customs website: www.hmrc.gov.uk
Charging deposits and the tenancy deposit law
You may ask the tenant to pay a deposit before moving into your property. This can act as security in case the tenant leaves the property owing rent and/or, pay for any damage and/or be used for missing items at the end of the tenancy. Click here for more information.
Should I provide a rent book?
You are only legally obliged to provide a rent book if the rent is payable on a weekly basis. Keep a record of rent payments and/or provide receipts to avoid any disagreements later.
[*]Your only or family home is the one where you/your family live for most of the time
[†]A lodger is someone who pays to live in your home, sometimes with meals provided, and who often shares the family rooms