When you let rooms in your own home as residential accommodation, you can receive the rent tax-free if it falls within the limits for rent-a-room relief. This relief is currently capped at rents of £7,500 per year. Where more than one person receives the rent from the property, each person has a tax-free exemption for rent of £3,750.
The conditions for rent-a-room relief stipulate that you must occupy the property as your main home at some point in the tax year – this relief can’t cover income from a holiday home or buy-to-let property. Also, the accommodation must be used for residential purposes, not as an office or store room.
If you let out land or buildings which don’t qualify for rent-a-room relief, the income could be covered by the £1,000 property income allowance. You can’t use this allowance against rent paid by your own company, a company you work for, or one your spouse is associated with.
If either type of rental income exceeds the relevant allowance, it must be declared on your tax return, along with any related expenses. If the allowance exceeds the actual expenses, you can deduct that allowance in place of those expenses.
Cash and finance costs
Individual landlords of residential properties are subject to restrictions on how much interest and finance costs they can deduct from rental income.
In 2019/20 individual landlords are permitted to deduct just 25% of their interest and finance charges for tax purposes. From 6 April 2020 all such finance costs will be disallowed. In place of the blocked interest the landlord receives a 20% tax credit to set against his Income Tax bill. This restriction of interest deductions doesn’t apply to corporate landlords.
Where the property business is supported by borrowing, the increased taxable income can push the landlord’s total income into higher tax bands, leading to the loss of allowances or the clawback of Child Benefit.
The example below compares an English landlord’s tax position in 2019/20 (when he deducts 25% of the £32,000 interest paid) with his position in 2020/21, when all his interest is blocked. The amounts of Personal Allowance (£12,500) and Basic Rate Band (£37,500) are estimated for the later year. The figures will be different for Scottish taxpayers, who pay tax on property income at slightly different rates.
|Rents less running costs||34,000||34,000|
|Total net income||61,000||69,000|
|Tax charged at 20%||7,500||7,500|
|Tax charged at 40%||4,400||7,600|
|Tax credit on disallowed interest at 20%||(4,800)||(6,400)|
|Total tax payable||7,100||8,700|
If your residential property business is supported by large borrowings, you need to urgently consider whether to restructure that business to avoid significantly higher tax bills. Your choices may include:
- selling one or more residential properties to reduce your borrowings
- selling all residential property and reinvesting in commercial buildings (the interest restrictions don’t apply)
- letting homes as Furnished Holiday Lettings (which are not affected, but require detailed conditions to be met)
- transferring the properties into a company
The last option is not easy as the lender will have to agree to transfer your property loans to the company. The transfer of properties is likely to incur land tax charges for the company, and may well generate a taxable Capital Gain in your hands.
Since April 2017 individual landlords with turnover of no more than £150,000 should use the ‘cash basis’ to draw up their accounts. This has the effect of taxing income in the year it is received and expenses in the year they are paid. It may benefit you if your tenants tend to pay late. You can opt out of the cash basis if you wish.
We can help you model the financial future for your residential property lettings.
The ATED trap
The Annual Tax on Enveloped Dwellings (ATED) applies when a company (and certain other bodies) owns a UK residential property worth over £500,000. The charge applies for the year from 1 April, but the ATED return, and any payment due, must reach HMRC by 30 April within that period (i.e., by 30 April 2020 for 2020/21).
This annual charge starts at £3,650 and increases, through valuation bands, up to £232,350 for 2019/20. The charge is based on the property’s value as at 1 April 2017, or the purchase date if later.
The owner can claim 100% relief from ATED if the property is let commercially, is under development, or if certain other conditions apply, but the relief must be claimed on an ATED relief form by 30 April for each year.
There are steep penalties for late submission of ATED returns, which are payable even if there is no ATED charge to pay. HMRC can check whether an ATED return is due by accessing the Land Registry database to see who owns which properties.
Registered as Auditors in the United Kingdom by the Association of Chartered Certified Accountants.