There are many issues for the prospective investor to take into consideration before deciding to plunge into property letting. Good impartial advice is needed from lawyers, banks and surveyors. This briefing assumes that specialist advice has been taken and will concentrate on the tax aspects involved in the purchase, letting and sale of let residential property. It will also consider the options available for holding property.
Buying UK property
Stamp Duty Land Tax (SDLT) must normally be paid by the purchaser of the property within 30 days of completing the purchase. The rate of the tax is determined by the value of the property and SDLT is payable on its full value at the rate of the band into which it falls. The rates currently vary between 0% and 4%.
Where the purchase price includes fixtures such as carpets, the purchaser is responsible for establishing a ‘just and reasonable’ apportionment of the sale price between the property and the fixtures. No SDLT is due on fixtures.
Letting property in the UK
The letting of property in the UK is treated for income tax purposes as a UK property business. Where more than one property is rented out, the letting of all the properties is treated as a single business, which allows a loss made on one property in a year to be effectively set against profits made on others. No distinction is made for these purposes between property let unfurnished and furnished, except for the special rules which apply to furnished holiday lettings (see below).
Make sure record keeping is good
Accounts should be prepared for the business in accordance with generally accepted accounting principles, although in most cases this should simply mean making sure that all rental receipts have been recorded and only expenditure of a revenue nature has been deducted in arriving at profits.
Rents should be included on the basis of the sum actually due for the tax year. This means that any rent paid in advance that relates to a period after the end of the tax year should be brought into account not when it is received but in the following tax year. If you exclude such a receipt in year 1 make sure you remember to pick it up when you prepare your figures for year 2.
You can claim expenses which are revenue in nature. Capital items cannot be claimed directly against income although some other relief may be available. You must also show that the expense is incurred ‘wholly and exclusively’ for the purpose of the letting business. If an expense has a personal element, it is generally apportioned, with only the business element allowed as a deduction.
Typical expenses that can be claimed will include:
advertising for tenants (but not for sale)
agents’ fees in relation to the letting but not the purchase or sale
expenditure on maintaining common areas of a building
fees in respect of finance arrangements
interest on borrowing to fund the purchase (don’t simply claim the total sum payable to the lender in the year as this will probably include some capital repayment as well)
expenditure on various forms of insulation (ie loft) can be claimed up to 1 April 2015 (there are some restrictions on this so you need to check carefully)
any expenditure on services such as gardening or cleaning that you agree to provide.
Expenditure on the building
There may be a particular issue in dealing with expenditure on the fabric of the property. A repair can be deducted from income but where there is a clear element of improvement that takes the property beyond its original condition, then the repair will be regarded as capital and cannot be claimed against income.
Common items of repair that can usually be claimed will include:
exterior and interior painting and decorating
damp and rot treatment
mending broken windows, doors, furniture and equipment such as cookers
replacing roof tiles, flashing and gutters.
Where expenditure is clearly of a capital nature and results in an improvement to the property, it may be possible to claim the cost of it in calculating the capital gain when the property is sold. Improvement expenditure is deductible against the gain, provided it is still reflected in the state of the property at the time of the disposal.
Expenditure on furniture and fittings
The capital allowance rules that give some deduction for plant and machinery expenditure do not generally apply to the rental of residential property.
Where a property is let on a furnished basis there is an optional allowance towards the cost of furniture. HM Revenue & Customs (HMRC) allow a 10% deduction of the net rents to cover the wear and tear on furnishings such as carpets, beds, settees etc. Net rents means the rental income less certain costs incurred by you as landlord but which are normally incurred by the tenant - essentially council tax and water and sewage rates. There is no requirement to demonstrate actual expenditure on the replacement of these items.
As an alternative, where the property is let furnished, the landlord can claim a renewals allowance when furniture and fixtures such as baths etc are replaced. The allowance cannot cover the original cost of the item, nor can it include any improvement element in the replacement. This latter relief is also available on fixtures where a property is let unfurnished.
Capital gains on the sale of the property
When the property is sold there may be a liability to capital gains tax (CGT) on the disposal. The gain is calculated by deducting from the sale proceeds:
the original cost of purchase
the incidental costs of purchase and sale such as legal costs and estate agents’ fees
any improvement expenditure which is still reflected in the state of the property.
Where the property that is being sold has also qualified at some time during the ownership of the vendor as their only or main residence, part of the gain may be exempt. In addition a letting relief of up to £40,000 may be claimable. Note that this is generally available to anyone with a share in the property meaning a couple, even if married, could potentially qualify for relief up to £80,000.
Any gains above the annual exemption which is currently £10,100 will attract CGT at a rate of 18% (subject to any Budget changes on 22 June 2010).