Tax on property income held by partners in law firms
Written by Gwen Rowlands, Tax Senior at Armstrong Watson
All things rental
Do you have a property, other than your main home, anywhere in the world, which you rent out? Does HMRC know? Not informing HMRC of your circumstances could be considered tax evasion, and the penalties could be severe. It is best to advise HMRC of your position as soon as possible, as penalties can be substantially reduced for unprompted disclosure.
HMRC require that you advise them of any rental income you receive over £1,000 through your Self Assessment Tax Return, even if your total income in the year is below your tax free personal allowance.
Is the property owned by you and your spouse/civil partner? The general rule is that the ownership will be shared equally, unless the property was purchased in different ownership proportions, e.g. if the house was purchased by one person before they got married, then the property would be in that person’s sole name unless transferred.
If the property was purchased whilst married, you are deemed to share ownership equally. If you wish the property to be owned in a different proportion, then a declaration of trust can be written up setting out the ownership percentage and the date the declaration came into force. This document cannot be backdated. You may want to consider this option if the property is rented out and your spouse/civil partner’s income is taxed at a lower rate than you or vice versa.
Property income allowance
Since 6 April 2017 HMRC have allowed you to earn £1,000 of income from your residential property without notifying them.
This is to cover small amounts of ad hoc rental income, for example, you let your spare parking space for a minimal weekly amount, or you rent your home out for a couple of weeks per year. If your annual gross property income is £1,000 or less, from one or more property businesses you will not have to tell HMRC or declare this income on a tax return
If your income receipts exceed £1,000 in the year but your expenses are less than £1,000, then the allowance can be claimed instead of the expenses, giving a reduction of £1,000 against the rental income receipts. In this scenario and if your rental income, before deduction of costs, exceeds £1,000, HMRC must be notified and a Tax Return completed.
If the property is owned jointly then both owners can each claim £1,000 on their share of income.
Unfortunately this allowance in not permitted for commercial property or property held in a partnership/company.
The minefield of allowable costs you can use against your rental income
Some of the costs that may be allowable against your rental income are included below. This is a rough list and by all means not comprehensive:
- Letting agent/management fees
- Accountancy fees
- Building and contents insurance
- Mortgage interest (although this is now restricted – see below)
- Maintenance and repairs to the property (but not large/capital improvements – see below)
- Utility bills, like gas, water, and electricity
- Rent, ground rent, service charges, council tax
- Services you pay for, like window cleaning or gardening
- Other direct costs of letting the property, like phone calls, stationery and advertising
Capital expenses
If the expenditure is a replacement or repair of an item, it is usually allowable as an expense. On the other hand, if you are enhancing the property by making it better or replacing an item with a better quality item or fixture, it is usually classed as a capital expense and therefore not allowable as a rental expense against your income. This cost can be taken into account as an enhancement cost, and added to the cost of the property and tax relief will then potentially be obtained when you come to dispose of the property when calculating any capital gains liability.
Finance cost deductions on residential letting
We are now more than half way through the HMRC phasing stages, from allowing mortgage interest as an expense in full, to allowing the mortgage interest as a reduction of tax at 20%.
The tax year 2018/19 sees only 50% of the interest being allowed as an expense against rental income (this reduces further in 2019/20 to 25%, and nil from 2020/21).
The other 50% of interest is currently used as a tax reduction calculated at 20% (75% of the costs will be treated this way in 2019/20, and the full amount from 6 April 2020).
Those who are higher rate or additional rate tax payers will suffer additional tax due to this change.
For example
A landlord has the following rental income in 2018/19 and is a higher rate tax payer (40%).
Rental income after deductible expenses £10,000
Less: mortgage interest (total £3,000 x 50%) (£1,500)
Total taxable income £8,500
Tax due at higher rate 40% £3,400
Mortgage interest deduction (total £3,000 x 50%) £1,500
Tax deduction (£1,500 at basic rate 20%) (£300)
Total tax due 2018/19 £3,100
The landlord then has exactly the same income in the 2019/20 tax year to compare
Rental income after deductible expenses £10,000
Less: mortgage interest (total £3,000 x 25%) (£750)
Total taxable income £9,250
Tax due at higher rate 40% £3,700
Mortgage interest deduction (total £3,000 x 75%) £2,250
Tax deduction (£2,250 at basic rate 20%) (£450)
Total tax due 2019/20 £3,250
As an additional warning, if your income was previously just under the £50,000 mark, and you were in full receipt of Child Benefit, your income will be increased due to this change and so you may have to repay some or all of your Child Benefit should the £50,000 mark be exceeded. The repayment of Child Benefit must be declared on your Self Assessment Tax Return.
Rent-a-room and Airbnb
Rent-a-room is a valuable tax relief allowing you to let furnished room/s within your home and covers total gross rents up to £7,500 in the year. These days, this can slot nicely into Airbnb or Bed & Breakfast type income.
If your total rental income is £7,500 or lower, you are not required to complete a Tax Return but you will if it exceeds this amount.
HMRC state rent-a-room can not be claimed if the room is –
- not part of your main home when you let it
- not furnished
- used as an office or for any business – you can use the scheme if your lodger works in your home in the evening or at weekends or is a student who is provided with study facilities
- in your UK home and is let while you live abroad
The above rules should be considered with regard to your Airbnb, and whether it will qualify for the rent-a-room relief, as an example, an outbuilding would most likely not qualify.
Letting Relief changes from 6 April 2020 on the disposal of your rental property
Changes are due to come into effect from 6 April 2020 with regard to letting relief when you dispose of your property.
This could apply for example if you own your own home as a single person and then find the love of your life, who you subsequently move in with and enter into marriage or a civil partnership, but you retain your original home and rent it for an income. Currently, when you come to sell the property you may be able to claim letting relief, and if the property is owned jointly this is worth up to £40,000 tax relief each so a very worth while claim to make if your property has increased in value over the years.
However, HMRC has announced that lettings relief will be reformed so that it only applies where an owner is in shared occupancy with a tenant. These changes will take effect from 6 April 2020.
If you are looking at disposing your rental property and this scenario applies to you, you might want to consider selling before the new reforms take place, but in any case please take advice before those signs go up.
Summary
Property and rental income may appear straight forward on the face of it, but there are many tax implications that should be considered some of which are outlined above.
It is essential that you take appropriate advice prior to entering into any property transaction whether that is a purchase, sale or renting your property, as all tax implications and planning opportunities should be considered.
For tax planning advice, get in touch with Gwen on 01228 690200 or by emailing gwen.rolands@armstrongwatson.co.uk