The income you receive as rent is taxable and you need to declare any rent you receive on your Self-Assessment tax return. The tax on your income is charged in accordance with your income tax band – 20% for basic rate taxpayers, 40% for higher rate taxpayers and 45% for additional rate tax payers.
When landlords pay tax on their rental profits, they can generally deduct certain expenses before arriving at the figure on which tax is payable.
Allowable expenses currently include:
- Interest on buy-to-let mortgages and other finance charges*
- Council tax, insurance, ground rent
- Property repairs and maintenance
- Legal and other professional fees such as those paid to a letting agent
*Changes announced in the 2015 Summer Budget were made relating to the treatment of income tax to buy to let investors, and from April 2017 the deduction of mortgage interest will gradually be replaced with a tax relief allowance that will partly offset the tax calculated on rental income.
To give landlords time to adjust, the amount of tax relief that applies will be phased in over four years from April 2017 as follows:
2017/18 – the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% available as a basic rate tax reduction.
2018/19 – 50% finance costs deduction and 50% available as a basic rate tax reduction.
2019/20 – 25% finance costs deduction and 75% available as a basic rate tax reduction.
2020/21 – all finance costs incurred by a landlord will be available as a basic rate tax deduction.
The changes will mostly affect higher and additional rate taxpayers, as the rate of relief is effectively reduced on interest costs from their marginal rate to the basic rate (currently 20%).
It is also possible that a basic rate taxpayer could find him or herself nudged into a higher rate band as a result of these changes and the way income is calculated before any deduction of mortgage interest.
How might this look?
A buy to let property is bought for £300,000
A £240,000 mortgage is taken out on the property
Mortgage interest is assumed at 4.5% - annual mortgage interest is £10,800
.e rental yield is 5% - annual rent is £15,000
For a basic rate taxpayer
| |
2016-17 |
2017-18 |
2018-19 |
2019-20 |
2020 onwards |
| Annual rental income |
15,000 |
15,000 |
15,000 |
15,000 |
15,000 |
| Mortgage interest payable |
(10,800) |
(10,800) |
(10,800) |
(10,800) |
(10,800) |
| Reduction in mortgage interest allowance* |
|
2,700 |
5,400 |
8,100 |
10,800 |
| Total rental income on which tax is payable |
4,200 |
6,900 |
9,600 |
12,300 |
15,000 |
| Tax at 20% |
840 |
1,380 |
1,920 |
2,460 |
3,000 |
| Tax at basic relief - 20% of the reduction in mortgage interest allowance |
|
(540) |
(1,080) |
(1,620) |
(2,160) |
| Total tax payable |
840 |
840 |
840 |
840 |
840 |
For a higher rate taxpayer
| |
2016-17 |
2017-18 |
2018-19 |
2019-20 |
2020 onwards |
| Annual rental income |
15,000 |
15,000 |
15,000 |
15,000 |
15,000 |
| Mortgage interest payable |
(10,800) |
(10,800) |
(10,800) |
(10,800) |
(10,800) |
| Reduction in mortgage interest allowance* |
|
2,700 |
5,400 |
8,100 |
10,800 |
| Total rental income on which tax is payable |
4,200 |
6,900 |
9,600 |
12,300 |
15,000 |
| Tax at 40% |
1,680 |
2,760 |
3,840 |
4,920 |
6,000 |
| Tax at basic relief - 20% of the reduction in mortgage interest allowance |
|
(540) |
(1,080) |
(1,620) |
(2,160) |
| Total tax payable |
1,680 |
2,220 |
2,760 |
3,330 |
3,840 |
These income tax changes do not apply to limited companies so some buy to let investors may want to consider restructuring their portfolio into a limited company. However, you should always take professional advice before making a decision.