I inherited my parents’ property earlier this year, and I’m considering letting it out to generate some income. Will I pay tax on this, as it is the only property I let? I own my own property with a mortgage, and am still working.
There are two critical things to remember when working out your taxes on rental property – your sources of income and your expenses. That sounds fairly simple, but you can generate income from more than rent – payments for other services provided by you, such as cleaning of communal areas, bill payments and arranging repairs all count as income, as will parts of deposits that aren’t returned when the tenants leave the property.
To work out your taxable profits, you total your income and then deduct expenses. These are the costs you incur when running and maintaining the property – including but not limited to landlord insurance, letting agency fees, advertising for tenants, ground rents and service charges, wages of gardeners or cleaners and even direct costs you incur, like phone bills and stationery.
The key thing is that these expenses should have been exclusively incurred as a result of renting out your property. However, you can deduct parts of expenses (say, for example, you pay the utility bills on a property that’s partly rented out and partly private) from your income if they are not exclusively incurred. You also get a 20 per cent tax credit for the interest charged on a mortgage on the rental property. You own the property outright, so you cannot claim buy-to-let mortgage tax relief, as it’s known, but it can be a useful credit to claim should you decide to leverage up on the property.
So, how much tax will you pay? Rental profits are treated as income, so are taxed at income tax rates. In Scotland you pay between 0 per cent, 19 per cent, 20 per cent, 21 per cent, 41 per cent or 46 per cent, depending on how much income you earn in the tax year and the band into which rental income falls.
If the rental income was your only source, you’d enjoy a £12,500 tax-free allowance, meaning that you’d only pay tax on profits that exceed this amount. However, as you are earning a salary, your rental income will be added to this other income. This could see you paying a lower rate on your salary and a higher rate on your rental income. For example, say you earned £45,000 a year from your job, and made £10,000 in taxable rental profits. Your salary and the first £5,000 of rental profits would be taxed at 20 per cent. However, the remaining £5,000 tips you over the £50,000 threshold for higher-rate tax in 2020-21. You'll pay 40 per cent on the £5,000 above this threshold.
Depending on how much you earn, you may need to complete a tax return. This is triggered when your total income from property is above £10,000, or your rental income is above £2,500 after expenses. If it’s below this amount, you may be able to have the tax deducted from your tax code.
If you do decide to become a landlord, there are lots of legal obligations you have to follow – find out more at which.co.uk/landlord.
Gareth Shaw is Head of Money at which.co.uk