Can I minimise tax on rental income?
Jonathan Riley recently answered this question in the September 28/29 2013 edition of FTMoney.
I plan to rent out the flat that I have owned for seven years and move home to save money. What is the best way to minimise tax on rental income and capital gains? A friend told me that I am exempt from capital gains tax (CGT) in the last three years of ownership. Is this correct and, if so, does it mean that I wouldn't have to pay tax if I sold it after three years? What if my circumstances change and I move abroad with work? Also, is there a big difference to the amount of tax I pay on rental income if it exceeds £15,000 a year? I am a higher-rate taxpayer in full-time employment.
Jonathan Riley, partner at Michelmores, says a simple way to minimise income tax on rental income is to claim all the allowable expenses. For example, your taxable rental income can be reduced by your mortgage interest, the costs of insurance, all safety checks, estate agents' legal fees, legal accountancy fees, repair costs and council tax. But you will need to keep receipts relating to these expenses.
Also, although you cannot claim the cost of any improvements, what is categorised as a repair can be surprising – for example, HM Revenue & Customs (HMRC) generally accepts that the cost of replacing single-glazed windows with double-glazed equivalents counts as a repair rather than an improvement.
If the flat is furnished, you may also claim 10 per cent of the rent against tax, as "wear and tear" each year. If you make a loss for any reason you can include it in your tax return and carry it forward to set against any future rental profit.
As a higher-rate taxpayer you will pay tax on your rental profits at 40%. You will also need to tell the HMRC about any rental income you have received before October 5 after the end of a tax year in which the property has been let. If the total rental income for a tax year is £15,000 or above, you will need to complete a full tax return. If it is less that this you only need to complete a shorter, four page return.
If the property has been your main residence during your ownership, then when you sell you should qualify for main residence relief from CGT. Your friend is right in that even if you do not live in the property you will still be entitled to the relief. If your period of non-occupation exceeds 36 months, however, a proportion of the gain will be chargeable to tax.
It is also worth remembering that if the non-occupation is because you have let the property, the gain may qualify for letting relief. To establish this relief, you need to work out the gain that is attributable to the period of letting.
Assuming the gain is £150,000 and that you owned the property for 10 years and let it for four years, the gain attributable to the letting would be £60,000. The relief works by exempting this gain but only up to a certain amount. In this example a maximum of £40,000 would be exempt with any gain above this subject to CGT.
Because you are a higher-rate taxpayer, our capital gains tax rate will be 28 per cent. To arrive at the gain you will need to deduct the acquisition costs and any enhancement expenditure from the sale proceeds.
Additionally, you will also have your annual capital gains tax allowance, which for the forthcoming tax year is £10,900.
If you move abroad and become non-resident then regardless of the above you will not be liable to pay capital gains tax when you sell. The tax will, however, become chargeable if you do not remain outside the UK return for at least five complete consecutive tax years. Even if you are non-resident, your tenants – or a letting agent – would need to deduct basic rate tax from the rent (under what is known as the "non-resident landlord scheme").
In certain circumstances you can apply for the income to be received without tax deducted – although the rent may still be subject to income tax, you would at least have the funds until the tax is due.