Property rent is also subjected to the income tax same as income earned from any other real estate properties. Owner often pays more income tax than is actually required to pay. And the reason is lack of knowledge about deductions. Investments in real estate offer deductions which can minimize tax on rental income by balancing profits and losses. After calculating the overall income from rental properties, one should calculate all the expenses on operating the rental properties. While calculating the payable taxes, Rental property holder should minimize the income by deducting owning charges, maintenance charges etc. Keeping profits and losses in view, there is quite a need for the landlords to know the tips on how to Reduce Paying Tax on Rental Income. After reading this article one will be able to know how income is calculated and what taxes are required to be paid.
Your rental income will mainly come from the rent you receive, but it also includes other costs you pass on to your tenants. Examples include cleaning and maintenance charges for communal areas and any utility bills included in the rent. You also need to have any portion of your tenant’s security deposit, which you retain at the end of the tenancy.
“However, you can deduct these costs as allowable expenses. ”
Landlords with more than one property can add together the rents they receive from all their properties and remove all of their costs. This means that you are allowed to offset expenses from one property against rents from another.
Recent tax changes for landlords
Previously, landlords could claim for the interest element of their mortgage. This was a valuable benefit to landlords who are higher-rate taxpayers. New rules – which have been phased in and were fully operational from April 2020 – mean you can no longer make this claim. Instead, you will receive a tax credit based on 20% of your mortgage interest payments.
Here are a few tips gathered by Legend Financial to help you minimize tax on your rental income.
Claiming all expenses
You can’t try to pay a tax on your payment; however, you can diminish your assessment bill by guaranteeing a portion of the costs (tax help) which accompany leasing property. Passable costs are the everyday expenses of dealing with your occupancy. They include:
- Landlord insurance – buildings, contents and public liability
- Letting agent and management fees
- Ground rent and service taxes
- Cleaning and gardening fees, which you pay for
- Accountants’ fees
- The cost of advertising for tenants
- Stationery and phone calls are used directly for your property business.
When it comes to ensuring a reasonable rent, you must determine how much space your business requires. Calculate your monthly outgoings for the expenses you want to claim, then divide that figure by the percentage of your rooms that are used for business (which should usually be one room). For example, if you have a house with seven rooms, an office should occupy one of them, so the rent is based on one-seventh of the eligible expenses. If your office was open seven hours a day on average, you would calculate 7/24th of the total and include it as rent in the agreement.
Creating Joint Ownership
One can buy rental property with fellow investors when it seems difficult to afford a property single-handed and also to reduce the taxes. While investing with a partner, one should know the rental tax details of joint ownership. Income tax on any of the partners is calculated by summing up all of his incomes.
It is important to know that the refundable security amount paid by the tenants is not added to the income as it shall be returned to the tenants. Its only purpose is security, and if any damage is caused by the tenant to the property, this amount is utilized for the repairs. Joint ownership can be created with either a spouse or some other investor (fellow or businessman,).
Many people assume that when a property is jointly owned, any rental income would have to be distributed according to their ownership of the property. For instance, where a rental property is owned 50:50, then the natural assumption is that the rent is distributed in the same proportions. However, there are situations where the rent can be shared out in varying proportions with tax advantages to each party.
Form a limited company
Individually buying a property and owning it results in more income and hence more tax. It is often better to establish a limited company for one’s rental properties. This way one only has to pay for the corporate tax and not the individual tax.
As property now belongs to that limited company, the owner can also pay himself a pay from company. Property belongs to the company so rental charges will also be made differently. There are tax benefits of a limited company although it is very time consuming.
However, pros and cons should be weighed and option of a limited company should be chosen if owner tax bracket is high and future plans are also dependent on investment in real estate sector.
“Transfer of property through a limited company will cost less transfer charges.”
One will not be required to pay stamp duty, inheritance charges etcetera. Moreover, there is limited liability with use of limited company. As there are benefits, there, may be some problems as well, like landlords will have to be more responsible. Moreover, cost of switching the company will have to be paid, and if profits are taken out of company, then income tax will have to be paid as per the existing laws.
Reducing through Extending
Investing in your existing properties will help you avoid hefty stamp taxes while also increasing the value of your portfolio. Because of recent changes in development rights, you can now extend your existing property further than you could previously, increasing your monthly income.
Real gains can be made by growing or expanding your property, provided you consider the ceiling price of the area in which your rental is located. However, keep in mind that if you are making significant improvements that may increase occupancy, you may be impacted by the upcoming changes to the HMO rules.
There are ways to reduce your landlord tax bill if you are between tenants. Council tax and utilities can all be claimed as expenses during this period, but wouldn’t you instead be earning money than saving? It is sometimes worthwhile to consider taking on a relatively short let during a void period in order to generate some income.
“Owner has the property for rent and he has the option to rent it on a short or long-term depending on his choice and need.”
A long term is normally referred to as 12 months or more. Long term occupants have their own cons. For example, owner cannot raise their rent as their demand is often a fixed rent for the whole duration of occupancy. Moreover, one cannot fix the problems in repair and maintenance well before time unless there are critical repairs needed. This all results in huge expenses and profit loss to the owner. Keeping in view the occupant rights, owner cannot terminate agreement till the time duration is not completed. These all cons can be addressed by having short term occupants.
Though, long term occupants offer a very predictable income and ease of management even then it is better to have short term clients. A short term may be referred to as a day, a week or a month. Owner can fix the rent rates as per the market whenever he wishes to do so. A short-term rent can generate 2-4 times more profit as compared with long term rental facilities. Secondly, maintenance is quite easier and can be done well in time.
Landlords and owners must have the knowledge to cater for situations like this. If there is no occupant, then expenses of utility bills, miscellaneous taxes, maintenance charges should be claimed or deducted. Once tenants leave the property, proper procedure should be followed to carryout required maintenance and paperwork should be completed as per requirements. While big institutions have policies to do such tasks, small landlords should focus on best work within the rules.
Utilizing all available tax-bands
Owners pay taxes on rental properties as per tax bands defined for income tax. These bands may change every year as per the policy of government. Tax bands for rental property income are same as other income tax bands. At the end of financial year, owner must calculate in which band he belongs. After calculating and deducting all the expenses one can decide the corresponding band each of which tells a percentage of income as tax.
If owner receives income from any other source along with the rental property the tax band will be calculated by adding all the incomes. Losses and expenses should be calculated accurately so that lowest possible tax band is used for tax. Especially if gross income of an owner is less than the basic rate of tax band there will be 0% tax. With a mild mistake this figure can cause a lot of tax to be paid.
One other way is transferring property to your spouse, if her income tax bracket is less than you. Transfer of property will work from both sides. Firstly, it will lower tax as soon as it gets transfer on spouse name. Secondly, it will lower the tax on your property which is still on your name by lowering the tax band for you.
Utilize mortgage interest by changing to an offset buy-to-let mortgage
Deduction of interest on mortgages permits the landlord to reduce the income tax on rental payments by an amount equal to the total mortgage interest over the same financial year. Debts from banks, with a purpose of uplifting, improving the rental property has the eligibility for such deductions.
Sadly, such deductions from rental income are not permissible for financing and can only be utilized for corporate deductions by filling in a tax return at the end of the year. This permit minimizing income taxes
There is still a way by which, one can take away mortgage interest. Let’s say, an owner bought a rental property for which the yearly interest is £10,000, and the income for the same year from that property is £40,000. So, when filling out the tax return one can deduct this £10,000 interest from annual rental income, which makes total income equal to £30,000. Lenders should handover the documents containing the interest paid for each year.
You can reduce the mortgage interest you pay by changing to an offset buy-to-let mortgage. Although it has limited availability, it could help you keep property invested into your offset mortgage account. Less mortgage interest paid shows a higher annual ROI (return on investment), offsetting against additional tax that you must pay on your income.
Planning your payments
One of the most efficient ways to reduce the expenses is getting your income tax return before the given deadline. Filing the income tax return in time will stop the risk of getting a fine penalty. Filing for tax return earlier will also mean a faster tax return. Early filing gives reaction time in case of any misunderstanding and rough calculations. Whenever possible, owner should file for tax well before the deadline along with carry forwards if any. Risks of getting a fine penalty should never be faced.
Whatever income you earn on your property, set aside a fraction of the funds you make in a savings account. You can earn profits from your savings and pay your taxes with it. Besides, it would help if you always met the property tax deadline
Carrying forward losses
There is a possibility that owner of a rental property can deduct and mention all the expenses on tax return annually. However, this may not be the case always and current years expenses may not always come on same year’s tax return. Unless expenses of transportation, repairs and maintenance, depreciation and other taxes are not finalised it is advised that expenses must be carry forward for the next year tax return especially when owner is running rental facility at loss. If owner is operating more than one rental facility, he should calculate loss and gains from all the properties and if the total is a loss, it must be carried forward.
“As landlord, owner has the right to report losses and carry them forward.”
Criteria is that one must own at least 10 percent of rental property and should make executive judgments. Laws lower the write off if the owner has modified total revenue.
What is owner is failed to mention all the losses in carry forward? Owner should carry forward all the losses again whatever he has failed to mention on tax return. If the owner is using the rental property for personal use such as during vacations or holidays then he won’t be able to claim the expenses for said duration. If owner has only rented property for 6 months in a year, he will only be eligible for reporting and claiming losses and expenses for those 6 months of rental period.
Claiming Private Residence Relief
Private resident relief is permissible for only or main residence for an individual. Owner can claim it for main residence once he sells his property. There should not be any business activity on the property for which the relief is to be claimed.
However, Private residence relief can be claimed for the shared property where the owner and the tenants are living in same residence. Although, such cases will be very less but the owner can take benefit out of it. Once owner sells out the property, he is eligible to claim for the residence relief.
Claiming “home office” expenses
For rental property one can dedicate a portion of home such as a room as an office in a way that it is legitimate. Consequently, the owner can deduct an amount equal to expenses of running an office for rental activity once filling out income tax return. There is always a provision for running an office for rental operations. An office is required to deal and have meeting with the clients. Payments can also be collected at the same very place.
“If owner’s job is related to the field work, then home office will be utilized for the administration purposes.”
Once home office is established and declared, transportation charges can also be deducted separately. If office was far away from the owner’s residence, then the transport charges for conveyance to that office may have been considered as personal trips which will not be the case with home-based office.
Let’s now discuss what all expenses can be deducted for running a home office. There are two main types of home office deductions which are direct and indirect.
Apportionment refers to the distribution of losses and expenses between the owner and the tenants. Apportionment can be used as a tool for reducing the tax burden on the owner. Expenses are borne by the owner and balanced taxes are also paid by him. Just like apportionment in insurance where losses are divided by a percentage amongst the company and client through an agreement, it can be done in rental properties as well.
Owner can make a deal with the tenants by which both will be liable to pay a portion of tax expenses. Expenses may include maintenance and repair etcetera. Apportionment will help the owner get more profits especially in short term tenants and will also result in lowering the taxes.
Claim Replacement of Domestic Items Relief
Landlords can get benefit from Replacement Domestic Items Relief. Items replaced in a rental property result in lowering the tax by deducting the amount spent in replacement. On the other hand, a good set of items foe the tenants will result raised rental payments. Hence profits will ultimately rise.
To get eligible for Domestic items relief, following must be kept in mind:
- Rental house can be empty, partly empty or full and Charges should be sustained on buying an item for replacement
- Item purchased should be available for the use of tenants and the replaced item must not be used again.
Such relief is given against the income tax for items cost for replacement and fewer charges of item of improvement. Admissible relief is for items that may be:
- Moveable Items such as floor mats, screen sheets etc
- Domestic machines such as AC, deep freezers etc
- Items used in kitchen
- Electronic items such as TV
Anyone whose total rental income is more than £10,000 before expenses, or £2,500 after expenses, will need to file a tax return. If your rental income is less than £2,500 you should contact HMRC, as they may collect your income through PAYE. Each tax year runs from 6 April until 5 April the following year.
If your tax affairs are complex – you have more than one property, additional sources of income, you are considering renting out property through a limited company – or you don’t feel confident filing your return, you could benefit from engaging an accountant. As an expert, your accountant will know all the rules about taxation and rental income, which expenses you can claim, and which receipts you need to keep. If you choose an accountant, look for someone with property taxation experience.
Over and over again, landowners lose cash when they sell an investment property just on the grounds that they don’t make the most of the accessible assessment alleviation on proposition to them.
“Right now, the tax-exempt figure remains at £11,300, which is a very decent saving in anybody’s book.”
Normally, the most effective way to save tax as a property manager is to utilize both a splendid bookkeeper and a solid assessment consultant or the accountant who can help you constantly. This article is expected to feature a couple of manners by which landowners can bring down their tax bills, yet it isn’t planned to be substantial exhortation. Hope we have been a source of ease for your tax savings. If you need any help regarding avoiding tax on your rental income, feel free to ask us @Legend Financial.
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Renting out your property. (n.d.). Retrieved from gov.uk: https://www.gov.uk/renting-out-a-property/paying-tax
Work out your rental income when you let property. (n.d.). Retrieved from gov.uk: https://www.gov.uk/guidance/income-tax-when-you-rent-out-a-property-working-out-your-rental-income#:~:text=Replacement%20of%20domestic%20items%20relief,2016%20for%20Income%20Tax%20purposes.&text=an%20old%20domestic%20item%20provided,lessee%20in%20that%20d