As a landlord, you must pay tax on the money you make from renting out your properties. This guide explains how tax on rental income is calculated, the rates you will pay and your allowances.
What taxes do landlords pay?
If you are considering becoming a landlord or are new to being a landlord, you may still be familiarising yourself with the many processes and responsibilities you need to follow.
Making sure you pay the correct amount of tax is one of the essential legal requirements that you must comply with to avoid potential fines. This article focuses on paying tax on rental income in the UK.
Landlords are required to pay:
- Income tax on profit from renting out residential property.
- Class 2 national insurance if profits are £12,570 a year or more and what you do counts as running a business.
- Capital gains tax if you sell an investment property.
- Council tax if your property is empty.
If you set up your property business as a limited company, your tax requirements differ from if you personally own the property. We explain this in more detail further on.
What counts as rental income for landlords?
Rental income is primarily the money you receive from your tenants in rent but can include charges for additional services you provide, including:
- Hot water
You must also include any money retained from your tenant's deposit at the end of the tenancy.
You must declare your rental income in the tax year it is due, even if you're not paid until the next tax year. This guide should help you calculate your tax on rental income, but if in doubt, seek advice from a specialist accountant.
You can deduct allowable expenses you incur from your rental income to calculate your taxable rental profit as long as they are wholly and exclusively for your property business.
Examples of allowable expenses include:
- General maintenance and repairs to the property, but not improvements
- Bill such as water rates, council tax, gas and electricity
- Landlord insurance
- Letting agent's fees
- Accountant's fees
- Service charges and ground rents
- Phone calls, stationery and advertising
- Legal fees (related to tenant eviction, not for buying property)
You should declare any allowable expenses in the tax year the work was done, even if you don't pay the bill until the next tax year.
The first £1,000 of your rental business income is tax-free; this is your personal property allowance. For joint owners, both parties can claim the allowance, i.e. £1,000 each against their share of the gross rental income.
However, if you claim property income allowance, you are not allowed to deduct expenses, so you must calculate which option is more financially beneficial.
Buy-to-let tax relief
Landlords also receive a tax credit based on 20% of their buy-to-let mortgage interest payments.
For example, if you made £15,000 in a tax year of rental income and are in the 20% tax bracket, your rental income tax bill would be 20% of the £15,000 = £3,000.
If your mortgage interest payments were £10,000 in the tax year, you would work out the tax relief on this amount:
20% of £10,000 = £2,000
So, the amount owed to HMRC for rental income tax would be £3,000 - £2,000 = £1,000.
How much tax will I pay on my rental income?
The tax you pay on your property income will depend on the profit you have made, income received from other sources and any tax relief you are entitled to.
To calculate your profit:
- add together all your rental income
- add together all your allowable expenses
- deduct the expenses from the income
If you have multiple properties, all your rental income and expenses are lumped together, giving you an overall profit for the year.
To calculate your tax
Your rental income is added to your other income from your job or pension, and you are taxed according to the normal income tax brackets.
Taxable Income 2023 – 2024
Income Tax Rate 2023 - 2024
Deduct your buy-to-let tax relief
If you have a buy-to-let mortgage, you can claim tax relief for 20% of your mortgage interest payments.
How tax is calculated on rental income: an example
Here is an example of how your tax is calculated on your rental income:
- Your annual rental income is £36,000, and your allowable expenses are £5,000, so you make £31,000 in profit from your buy-to-let property.
- You earn £50,000 in other income, giving you a total taxable income of £81,000.
- You have a standard personal allowance of £12,570. You will pay no tax on this part of your income.
- You'll pay 20% on the £37,699 between £12,571 and £50,270 (£7,540) and 40% on the remaining £30,730, which falls into the higher rate tax bracket (£12,292).
- This gives you a total income tax bill of £19,832
- You have paid £20,000 in mortgage interest, so you are entitled to a tax credit of £4,000.
This leaves you with a tax bill of £15,832.
When do I pay tax on my rental income?
You pay tax on the rental profits you make in each tax year. The tax year runs from 6th April to 5th April the following year. You must file your self-assessment tax returns and pay your bill to HMRC by the 31st January following the end of the tax year.
For example, for rental income earned between 6th April 2022 and 5th April 2023, you must file and pay your tax returns by 31st January 2024.
What if I have made a loss?
You will make a loss if your expenses exceed your rental income. You can offset your loss against any profits you make from rental property in future years.
For example, if you made a £1,500 loss in the tax year 2022/23 but then made a profit of £4,000 in 2023/24, you can deduct the previous year's losses from the current year's profit. So, for the tax year 2023/24, you would only pay tax on £2,500.
What tax do I pay if I sell my rental property?
As a buy-to-let landlord, you'll be liable for capital gains tax (CGT) when you come to sell if the rental property in question has increased in value during your period of ownership. Indeed, most properties rise in value – capital appreciation is one of the main reasons people invest in property.
Property can be far more lucrative than other forms of investing, including stocks and shares. If you are in the basic tax band, you will pay 18% CGT on any profits from your sale. If you are in the higher tax band, you will pay 28%.
Corporation tax vs. income and capital gains tax
As a landlord, you can decide whether to set up your property business as a limited company or own property in your name. Choosing the ownership structure will determine which type of tax you pay and how much you pay, so you should do the necessary calculations to determine which option is right for you.
If you set up as a limited company, you are required to pay corporation tax which is:
- Profits up to £50,000 - 19% tax on all profits
- Profits between £50,000 to £250,000 – 25% (eligible for marginal relief)
- Profits above £250,000 - 25% tax on all profits (not eligible for marginal releif)
Corporation tax rates are more favourable than high-earner personal income tax rates of 40% and 45%, so many property investors choose to set up limited companies for this reason.
Also, limited companies do not pay capital gains tax (CGT) when selling a property, while personal owners must pay CGT.
Other benefits of setting up as a limited company include avoiding paying tax on profits by retaining the money in the business and using it as a deposit on another property.
Yet another benefit for a landlord paying corporation tax rather than income tax is that they can treat mortgage interest payments as a cost. A self-employed landlord cannot deduct mortgage interest as an allowable expense. Instead, they receive a standard 20% landlord tax relief (regardless of their tax band).
If you are unsure which property ownership option will be the most financially beneficial, you may want to speak to an accountant for professional advice.
If you are a London landlord looking for guidance and assistance in letting property in London, contact Plaza Estates, and we'll be happy to assist you.