Although the market for private landlords has slowed in recent years many still see the owning of residential property as a way of achieving a return on their investments, writes Simon Shaw of Duncan & Toplis.
In helping my clients make decisions about the ownership of rental property and completing their tax returns, there are many things to consider to ensure the tax liability on this income is minimised and therefore the return on investment is maximised.
The good news is that HM Revenue & Customs (HMRC) provide their property income manual which gives guidance on how the profits from property are calculated. Firstly, profits from land and property are treated, for tax purposes, as arising from a business. This means that many of the rules follow the same principles as those used for calculating business profits.
One area which can make a big difference to the tax payable is whether a cost is an improvement or a repair? The importance here is that a repair can be deducted from the income when calculating the taxable profit, but an improvement is added to the cost of the property. A repair is the restoration of an asset by replacing subsidiary parts of the whole asset. A simple example of a repair is replacing a roof tile blown off in a storm. A repair doesn't take place where there is a significant improvement, for example the roof is taken off and another storey is added to the building.
Although in many cases deciding if a cost is a repair or an improvement is straight forward, there can be cases where deciding this is not simple. This is often the case where a property is purchased in a run down state and money is spent bringing the property into a condition where it can be let out. In this situation the price paid for the property will often have reflected the need to carry out the work and therefore the initial cost of bringing the property into a condition where it can be let is an improvement and can't be set against income.
On a practical point I always advise my clients to take before and after photographs of any work so there is evidence of the nature and extent of any work carried out. This will allow an argument to be put forward to demonstrate the repair nature of the work, if this is challenged.
Where domestic items are provided such as household appliances, the costs of these can be claimed when they are replaced, but the initial purchase of these items is not an allowable cost.
For those with very low property income, a £1,000 property allowance is available which can be deducted from the gross property income instead of deducting the actual costs.
In recent years there have been big changes to the way interest on loans used to buy residential investment properties is deducted from income. For the 2019/20 tax year only 25% of the interest paid is deducted from the property income. A further tax credit of 20% of the interest paid is given on the remaining interest. Although for basic rate taxpayers the effect of this should be that they achieve tax relief on all the interest paid, there are situations where due to the rental income being a higher figure, they may be pushed into the higher rate of tax or be subject to the High Income Child Benefit Tax Charge.
For higher rate tax payers, the effect of these changes to interest relief is that they only get 25% tax relief rather than the 40% tax they are paying on their income.
For some, holding rental property inside a Limited company rather than in private hands can bring about benefits. The big plus is that tax on the rental profit is paid at 19% rather than 20% or 40% for individuals. On a property profit of £20,000 this saving could be as much as £2,200. Care must be taken when profits are drawn from the property company as this may incur additional tax which significantly reduces the tax saving.
When considering the use of a Limited company for property ownership there are many other matters to consider and therefore professional advice must always be taken before deciding to buy property in this way.
In conclusion owning rental property is very much like running any business and getting the right advice every step of the way will help you maximise the return on your efforts.