As a landlord, you will need to pay tax on the money you make from renting out your properties. This guide gives an insight into how tax is calculated in rental income, the rates you will pay and your allowances.
What taxes do landlord's pay?
You must pay income tax on any profit you make from renting out your property.
You may also need to pay class 2 national insurance if your profits are £6,515 a year or more and what you do counts as running a business. The gov.uk website has more information on when you are required to pay national insurance.
If you sell an investment property, you will be subject to capital gains tax on any profit you make.
As a landlord, you do not need to pay council tax unless your property is empty.
This article focuses on paying income tax on rental profits in the UK.
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 will also need to 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.
You can deduct expenses you incur from your rental income to calculate your taxable rental profit as long as they are wholly and exclusively for your rental 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
- Costs of advertising for new tenants
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.
Property tax allowance and tax relief
The first £1,000 of your rental income is tax-free, this is your personal property allowance. This allowance can be particularly beneficial for joint owners as both parties can claim the allowance, i.e. £1,000 each.
Landlords also receive a tax credit based on 20% of their mortgage interest payments.
How much tax will I pay on my rental income?
The amount of tax you pay on your property income will depend on the profit you have made, what you received from other sources and any allowances 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.
Subtract your property allowance and any tax credits to reveal your taxable rental income.
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 2020 – 2021
Income Tax Rate 2022 - 2023
How tax is calculated on rental income: an example
- You make £12,500 in profit from a rental property
- You can deduct your £1,000 property allowance
- You have paid £6,700 in mortgage interest, so you are entitled to a tax credit of £1,340 (£6,700 x 20%)
- This leaves you with a taxable rental profit of £10,160
- You earn £50,000 a year from your job giving you a total taxable income of £60,160
- If 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 portion between £12,571 and £50,270 (£7,540) and 40% on the £9,890, which falls into the higher rate tax bracket (£3,956). This gives you a total income tax bill of £11,496
Rental income vs trading income
Rental income is different to trading income in the sense that it is regarded as ‘a passive investment.’ In other words, the landlord isn’t involved in a lot of activity other than collecting rental income on a monthly basis, from a long-term asset.
Buying a property and refurbishing it, on the other hand, would be regarded as trading income because the property has been altered and sold on within a matter of months.
Rental losses can be carried forward to next year’s tax return (unless the rental property is an overseas let, a furnished Air BnB apartment or let out to family). Trading losses are more flexible in that they can be carried sideways and backwards, as well as forward. In certain cases, they can even be set against capital gains.
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 the 6th April to 5th April the following year. You must file your self-assessment tax return and pay your bill to HRMC by the 31st January following the end of the tax year.
For example, for rental income earned between 6th April 2021 and 5th April 2022, you will need to file and pay your tax bill by 31st January 2023.
What if I have made a loss?
If your expenses are more than your rental income, you will make a loss. This can be 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 2020/21 but a profit of £4,000 in 2021/22, you can deduct the previous year's losses from your profit so, in the tax year 2021/22, 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. Certainly, most properties do increase in value – capital appreciation being 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
A landlord registered as a limited company will pay corporation tax rather than income tax and capital gains tax. The reason for this is that they will pay less to HMRC if registered for corporation tax. That’s because as a limited company a landlord is due to pay just 19% tax on any profits he or she makes. From April 2023, this is up to a maximum of £50,000. After that the tax rate is 26.5% up to a ceiling of £200,000. Any further amount is taxed at 25%. This compares to income tax which is 20% for the first £50,000 profit, then 40%, with the highest tax payer band coming in at 45% against profit.
A corporate tax payer can also avoid paying tax on profits by retaining the money in the business and using it as a deposit on another profit etc.
Yet another benefit for a landlord paying corporation tax rather than income tax is that he or she can claim tax relief on mortgage interest payments (whereas the self-employed landlord receives a standard 20% landlord tax relief, regardless of which tax band they are in).
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.