Landlords and Rental Income Tax Return Preparation and Advice
Do I need an accountant to prepare a self assessment tax return including rental income?
We suggest that you do. Calculating rental profits is not straightforward as there are a lot of rules regarding which expenses you can claim and which you cannot. Getting this wrong can mean that you pay too much tax or result in HMRC investigating whether your tax return is correct.
Using an accountant may not be as expensive as you think and will buy you peace of mind.
We recommend using Excel to record your rental income and expenses. If you are not familiar with Excel we can calculate your profits from the paperwork associated with your rental business (letting agent statements, purchase invoices and receipts, mortgage interest statements. We can also set up an Excel template for you to use yourself.
If you would like a free no obligation meeting to discuss how we can help with the calculation of your rental income and self-assessment tax return just get in touch.
Do I need to complete a tax return if I have rental income?
You must contact HMRC by the 5 October following the tax year if you commence to have taxable profits from property you rent.
If you’re also employed and your rental profits are small enough, you can ask HM Revenue and Customs (HMRC) to deal with your profits by adjusting your PAYE code. If HMRC ask you to you will need to complete a self-assessment tax return including your rental profits. If you don’t usually send a tax return, you need to register for Self-Assessment by 5 October following the tax year you had rental income.
You can read more about completing a Self-Assessment Tax Return on our Self-Assessment Tax Return page.
From 6 April 2017 If your annual gross property income is £1,000 or less, you won’t have to tell HM Revenue and Customs (HMRC) or declare this income on a tax return.
If your annual gross property income is more than £1,000 you can use the tax-free allowances, instead of deducting any other expenses or allowances. If you use the allowances you can deduct up to £1,000, but not more than the amount of your income. This is known as ‘partial relief’.
If your expenses are more than your income it may be beneficial to claim expenses instead of the allowance as you will record a loss that you can offset against future rental profits.
Calculating your taxable rental profits
You can read more about how to calculate your rental profits here.
Cash basis of accounting
Most accounts are prepared under the accruals basis of accounting – which means that sales and expenses are recorded based on the date of the invoice and the period that the sales or purchase invoice covers.
Starting in the 2017/18 tax year landlords with a rental income of less than £150,000 p.a. can use a much simpler cash basis of accounting. This is the default method – and you must opt to use the accruals method. For most landlords there will be no disadvantage to using the cash basis and it is much easier. You simply record rental income and expenses when the funds are received or paid.
Your rental income is the rent you get but also other payments from your tenant for other services and repairs to the property. If you are letting through an agent, you must record the total rent as income and ant letting fees as a separate expense.
If your tenant pays a deposit this is not income. You should make a note of it and when it is refunded do not include it as an expense.
To work out your taxable rental profit you deduct any allowable expenses from your rental income.
Some costs are easily identifiable as allowable expenses. For example, your tenants call to complain about a blocked drain. Fixing this is an allowable expense, as is landlord buildings insurance. But what about the cost of getting a flat professionally cleaned before your first tenants move in, or adding a splashback so you don’t have to repaint the kitchen every year or even putting in a new modern kitchen?
To claim an expense against your rental income it must pass a series of tests laid down by HMRC but deciding isn’t always straightforward.
Wholly and exclusively for the letting business
To claim an expense against your rental income it must have been incurred by you wholly and exclusively for the letting business. Common examples include:
- general maintenance and repairs to the property, but not improvements (such as replacing a laminate kitchen worktop with a granite worktop)
- water rates, council tax, gas and electricity
- insurance, such as landlords’ policies for buildings, contents and public liability
- costs of services, including the wages of gardeners and cleaners
- letting agent fees and management fees
- legal fees for lets of a year or less, or for renewing a lease for less than 50 years
- accountant’s fees
- ground rents and service charges
- direct costs such as phone calls, stationery and advertising for new tenants
- vehicle running costs (only the proportion used for your rental business) including mileage rate deductions
Expenses you can’t claim a deduction for include:
- the full amount of your mortgage payment – only the interest element of your mortgage payment can be offset against your income
- buying a lawn mower that you also use at your own home
- private telephone calls – you can only claim for the cost of calls relating to your property rental business
Rental expenses – the capital expenditure test
Capital expenditure is where spending creates an asset of lasting use, or when you add something to the property that wasn’t there before. This includes improving or upgrading existing assets. Putting in a security system, a carbon monoxide detector or central heating which was not there before will fall under capital expenditure, as will the cost of fitting out a new kitchen that’s an improvement on the existing one. These things increase the value of your property and you cannot have tax relief on any of the cost. However, if the kitchen being fitted is of the same standard, size and layout, and is put in after your letting business has started, the whole cost can be set against your rental income.
Adding a conservatory to the back of the property or dormer windows in the loft space would fail the test because these would be a capital cost. Instead, costs like this should be deducted from capital gains when the property is eventually sold, and the capital gains tax is calculated.
Replacing a scorched worktop would be considered a repair not capital expenditure. But if you replace a cheap pine worktop with an expensive marble one, you won’t be able to claim the full cost, only the like-for-like. If you add a splashback to avoid annual redecorating costs, it will be capital expenditure because the splashback wasn’t there before.
Generally installing anything that wasn’t there before will be capital expenditure. However, some improvements that might appear to be capital expenditure will be allowed as costs. The cost of replacing old single-glazed windows with double-glazed ones, even though it’s not like for like, will be allowed because double glazed is the modern minimum legal requirement. It’s an unintentional or unavoidable improvement and there is no enhancement to the function of the asset. Although the new material used might be an improvement, the fact is it is broadly equivalent to the old material used.
You can read more about Capital Gains Tax and the calculation of Capitals Gains on our Capital Gains Tax Page.
Repairs and replacement of domestic items
Even when an expense is clearly not capital expenditure, it will then need to fit into one of two categories to be an allowable revenue expense. These categories are repairs and maintenance, and replacement of domestic items.
HMRC defines repairs as work that restores an asset to its original condition, sometimes by replacing parts of it. Repairs and maintenance costs can apply either to items within the property, such as a boiler, or to the property itself, for example work on the roof. And they are allowed on a like-for-like basis.
This means you can claim for example for the cost of fixing a burst pipe, redecorating and roof repairs. You can claim for renewing broken fixtures such as baths, showers, sinks and toilets. These are classed as repairs to the building, but they must be like-for-like replacements.
Painting and decorating on the exterior and interior are allowable maintenance expenses, as are mending broken windows and doors, and cleaning carpets. Fitting a new kitchen can be categorised as a repair to the property if it’s of the same standard and layout as the old one.
The replacement of domestic items is exactly that – with the emphasis on ‘replacement’. The initial purchases of furnishings and equipment for the property are not allowed, but their replacement is. The replacement of domestic items relief is available for furnished or unfurnished lettings. There are four sub-categories to this relief to help landlords see exactly what they can claim for:
- Movable furniture, for example beds and freestanding wardrobes.
- Furnishings such as curtains, linens, carpets and floor coverings.
- Household appliances, including televisions, fridges and freezers.
- Kitchenware such as crockery and cutlery.
You must only claim for the real cost of the item to you and the old item must not be available for use in the property. The replacement must be of a similar standard or value. For example, if you replace a bottom-of-the-range carpet you can only claim the cost of replacing it with another bottom-of-the-range carpet. You can buy a better carpet, but the extra cost can’t be claimed. Similarly, if you remove a carpet and replace it with more expensive wooden flooring, you can only claim the cost of a similar carpet.
A particularly tricky area is pre-letting costs. Generally, the costs of getting a property ready for letting will not be allowed, because most of these costs will be classed as capital expenditure or will fail the ‘replacement’ test. For example, you buy a new carpet to replace one in a property you have bought to let. But replacing a carpet will only be counted as a replacement once the letting commences. For the purposes of the letting business it counts as an initial purchase.
Many other costs that arise from putting a property right before the first letting commences will be classed as capital expenditure. HMRC designates certain costs as capital outlay before the business has started and the same things as revenue costs after the letting has started. For example, any work that needs to be carried out to let the property, such as rewiring, are likely to be classed as pre-letting capital expenditure.
You can claim for the cost of running adverts for tenants and letting agent fees, and for pre-letting gas and electrical safety checks. But work that needs to be carried out because of these checks will not be allowed.
Landlords are entitled to claim expenses incurred before the letting business began under the general business rules that allow you to claim for expenditure that was incurred within a period of seven years before the business began. To qualify, the expense must be one that would qualify as a deduction if it had been incurred after the rental business started – that is, it would need to be wholly and exclusively for letting and not capital expenditure. A useful general rule to use is that if, on the day of the purchase you could have let the property the cost of the repair should be allowed.
Note that if you are managing a letting business with more than one property, costs that you incur leading up to the letting of a second or other properties that are not capital expenditure will be allowed as deductions – unlike those incurred leading up to the first letting. This is because these will occur after the business has started and are not therefore pre-letting costs.
Mortgage interest relief
Under new mortgage interest relief rules for landlords, relief will be restricted to the basic rate of tax – 20 per cent. So top-rate tax-paying landlords will get back £20 in relief rather than £45 on every £100 spent on interest payments. Note that the relief will be applied as a tax credit rather than the landlord deducting costs from their rental income. The change will happen in phases. In 2017-18, the permitted deduction from rental income will be restricted to 75 per cent of the landlord’s finance costs. The remaining 25 per cent will be given relief at the basic rate of tax, even for 40 per cent and 45 per cent taxpayers. In the following year, 50 per cent of finance costs can be deducted and 50 per cent will be given lower-rate relief, and so on until in 2020-21 all financing costs incurred by a landlord will be given relief at the basic rate.
Profit calculation exceptions
Please note that there are different rules to follow if you’re:
- Renting a room in your home
- letting a property as a furnished holiday letting
- renting out foreign property
- letting a property in the UK while you live abroad
The calculation of rental profits is a particularly tricky area. If you would like a free no obligation meeting to discuss how we can help with the calculation of your rental income and self-assessment tax return just get in touch.