A guide for landlords on rental income

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As a landlord, you are responsible for the rental income when you buy a property. This includes ensuring the property is maintained and generating rental income. In this blog post, we will discuss some tips on how to generate income from your rental property. Keep reading to learn more! 

What is rental income?

Rental income usually refers to the gross income a property produces. For example, if a property produces £500 per month from rental payments, it would have an annual gross rental income of £6,000 (500 for 12 months).

Wallet representing rental income being paid

However, it can also mean the net rental income which means the profit a landlord received. To calculate this, all expenses must be deducted from the rental income. This includes home insurance if necessary, any bills the landlord pays, council tax, maintenance costs, mortgage payments and the property manager or letting agent fees.

Why do you pay tax on rental income?

Tax must be paid on rental income because it is used as another way the government taxes landlords. As of 2017, mortgage payments are no longer a tax-deductible expense for landlords. This was implemented by the government to stop tax relief for landlords who are higher-rate taxpayers.

The government favours new buyers entering the property market to keep the market fair. For example, there is no stamp duty relief for those purchasing a second home or using a buy to let mortgage for investment, penalising experienced landlords. In contrast, there is the help to buy scheme for first-time buyers purchasing new builds, incentivising new people to buy a house.

In addition, to help lower-income landlords, the government introduced a tax relief credit. Over the years from 2017 up to 2020, the percentage of mortgage payments that can be reduced from the tax bill has reduced to 0% and the percentage of the mortgage available for tax relief credits has increased to 100% in staggering amounts. Aiding lower income landlords.

These rates are seen below and show how the rates of a mortgage have been reduced. In 2022 onwards, for example, a landlord who made £10,000 will be first taxed using income tax and then be provided with a tax relief credit of 20% of the leftover amount.

Mortgage interest tax relief over the years

Tax Year Mortgage interest deductible (%)
Mortgage deductible at 20% tax credit (%)
2016-2017 100% 0%
2017-2018 75% 25%
2018-2019 50% 50%
2019-2020 25% 75%
2020-2021 0% 100%

 

What are the income tax rates?

Income tax rates recently changed in the new tax year and came in 2023. Coming into effect on the 5th of April 2023. This allows people earning a lower income to benefit from some tax relief by increasing the amount of personal income by £70 and increasing the amount of money you need to make in a year to fall into the basic income tax rate by £200.

If you are unsure of how to calculate your tax or if you have circumstances like a blind person allowance or a marriage allowance. Try looking at the government website here where there is a guide on the process.

2023 The Income Tax rates:

The below tax rates show the updated tax rates for 2023. You can use these rates to calculate how much tax is owed on the rental income from a property based on your tax band.

Taxable Income (2021 – 2022) Tax Rate Taxable Income (2022 – 2023) Tax Rate
Up to £12570 0% Up to £12570 0%
£12,571 – £50,270 20% £12,571 – £50,270 20%
£50,271 – £150,000 40% £50,271 – £125,140 40%
£150,001 + 45% £125,141 + 45%

 

How to calculate rental income

Rental income is important to calculate in order to work out how much you have to be taxed. However, it isn’t that complicated and there are resources laid out by the government to help landlords with this procedure. For example, the self-assessment tax returns page.

However, when it comes to calculating rental profit, a landlord should take the net rental income and then deduct all expenses.

It is essential a landlord takes into consideration all the types of property they own and calculates each one separately. Maybe they have a UK holiday let, a room to rent or even an investment property. Each of these categories has individual tax reliefs and grants so it is important you differentiate between them.

Gross rental income vs Net rental income – how to calculate it?

Gross rental income is a simple addition of all the rental payments collected in a tax year. This is known as the annual rental income. Net rental income refers to the income left over once all expenses have been deducted from the gross rental income.

Landlords like to calculate both types of income because net rental income is important for ensuring they will make a profit and be eligible to get approved for a mortgage.

A lender will typically use the figure of net rental income or rental yield to approve a mortgage before they lend money. This gives them confidence the mortgage will be paid back if the rental income surpasses the mortgage interest payments of a buy to let mortgage by at least 125% – 130%.

What are allowable expenses for landlords?

Allowable expenses no longer include mortgage payments. So, what do they include? Landlords should document all of the following expenses so when they calculate their tax payments and forecast the success of their business it is a simple process. 

To calculate taxable income, go through the list below and take all the allowable expenses away from the net rental income. This can be done easily using a rental income calculator. This makes things when making tax digital for landlords.

Rent repairs and insurance

Things inevitably go wrong when owning a property. Boilers may break and equipment may become damaged. You can evict a tenant for damage to your property under section 8 of the Housing Act 1988, however, there will still likely be standard maintenance you’ll have to do to your property that cannot be blamed on anyone.

This maintenance can be conducted regularly under planned preventative maintenance but there are also mandatory inspections that fall under repair costs like making sure there is a valid EPC certificate and Electrical Installation Condition Reports (EICR).

These costs can creep up on a landlord, notably if the landlord isn’t familiar with the property like if it was bought in an auction and tenants move and find a lot of problems with the property.

Loan interest

When landlords take out a mortgage for example if they invested in a buy to let property, there will be interest payments that have to be made to pay back the loan. This is classed as an expense because it is no longer tax deductible.

However, you may be able to qualify for tax relief on your mortgage payments at a rate of 20% if you are a certain type of landlord. Find out here if you fall into this category. 

Legal and Professional

As a landlord, you may have to pay professionals to conduct checks and help you with your property journey. This can include mortgage fees from setting up a mortgage, paying a property manager, letting agent, accountant or even surveyor. And, as part of these fees, you may have a homebuyer survey included which could justify the cost.

Depending on the type of property investment, legal and professional help can get quite expensive. Especially if a landlord is doing things like a renovation, or increasing the valuation of a property to increase their buying power in a mortgage. Or doing complicated manoeuvres like buying a property with no money.

Other expenses

An expense a lot of landlords don’t take into consideration is the expense of covering rent payments if there is a period of time when there is no tenant in the property paying rent.

This is quite a common occurrence in tenancies with Assured Shorthold Tenancy agreements but landlords who sign tenancy agreements for longer periods of time like those in build to rent developments can reduce the likelihood of this happening.

As well as this, gas and electricity payments are common to pay as a landlord if they own an HMO. Also, landlords can use mileage as a tax-deductible expense where they can claim back the miles driven in a car. Currently, it’s possible to claim up to 10,000 miles at 0.45p per year.

In addition to this, things like marketing, gardening for the property and phone bills all used to add tenants to the property can be expenses a landlord can deduct from their tax bill.

Money used for landlord expenses

As a landlord, how much tax do I pay on my rental income?

The exact amount you need to pay depends on if you have rental income in your personal name or a limited company. Typically, landlords who fall into the 40% tax bracket for higher-rate taxpayers will choose to invest in a limited company.

This is because if they didn’t, they’d have to pay a 40% tax on their rental income before paying any mortgage payments. If they do it through a limited company, a landlord can deduct a lot more expenses through tax and they’d pay just 19% corporation tax. 

Calculating rental income tax in your personal name

If you own properties or a property in your personal name, you are likely a basic rate taxpayer of just 20%. This is because you can usually save a lot of money as a higher-rate taxpayer if you open up a limited company.

As an example, if you earned £20,000 in rental income in a tax year, you could pay 20% of this in income tax straight away for £4,000, leaving you with £16,000 and then claim 20% of this back in mortgage interest tax relief credits. This would leave you with a total of £19,200.

Following this calculation, deduct any expenses from the property as mentioned. For example, you may have £4,000 of expenses leaving you with £15,000 profit. From here, deduct your personal allowance which is usually £12,570 leaving you with £2,430. 

You would then pay 20% tax on this £2,430 figure, paying £486 in tax. To declare this tax, you can go to HMRC and fill out a self assessment tax return here.

Calculating rental income tax as a corporation

Calculating tax on your rental income as a corporation is slightly different than if you were doing it in your personal name. First of all, there are additional expenses you can deduct from the profit of a business such as paying employees.

If you are a business owner without employees, you can pay yourself a salary here but it is worth noting you will still have to pay tax on this salary at the rate of income tax.

Overall, once you have deducted expenses, you will pay tax on your pre-tax profit of the business at a rate of 19% at the start of every financial year. This process is more common for landlords who earn a lot of rental income in the higher and additional rate tax bracket i.e., over £50,271 per year.

Let’s take an example of earning £200,000 from the business. £100,000 could be written off as a deductible tax expense (including employees). With the remaining £100,000, a company would pay £19,000 in corporation tax. If this sounds confusing or you need a second piece of evidence to compare it to you could use a rent calculator or a landlord tax calculator.

Manually calculating rent without a rent calculator

How do I pay less tax on rental income?

If you are paying a lot of tax, chances are you are a higher rate or additional rate taxpayer and you have properties registered in your personal name. In this case, listing your properties under a limited company could save you a lot of money.

Alternatively, you could spend a lot more money as a business expense in the tax year to reduce the amount of money you take home as profit. On the extreme end, a business can roll over a loss from previous years to pay no tax on a property.

For example, renovating a property to have a -£10,000 profit for the tax year in a limited company and making £10,000 net profit in rental income the following year will leave you with an overall £0 profit which you cannot pay tax on. 

Do you pay tax on rental income if you have a mortgage?

Yes, as of 2017, the government has started charging personal income tax on rental income before mortgage payments are deducted.

So yes, tax is calculated based on gross rental income rather than net rental income, making it easier to save tax as a limited company if you are a higher rate taxpayer than keeping property or properties in your personal name.

How to pay rental Income Tax from jointly owned properties

Jointly-owned properties have their own rules when it comes to tax. First of all, the share of the property you own will dictate the share of rental income paid to you in the same proportion. 

For example, if person A owns 80% of a property and person B owns 20% of the property, the rental income will be split into those amounts. If person A and B earned £10,000 in rental income net profit, person A would receive £8,000 and person B receive £2,000. 

They both would then be responsible for paying their own share of income tax based on their own income tax rates.

How much do married couples and civil partners pay?

Unlike, if you jointly own a property, rental income is split 50:50 if you are married or in a civil partnership. Both people in the relationship would have to pay the same amount of tax in this case.

This agreement doesn’t take into consideration the proportion each person pays. For example, even if person A owned 90% of a property and person A and B both received £10,000 in rental income, that £10,000 would be split 50:50 and then each person would pay their own share of income tax.

However, there is an exception to this rule. This is known as Income Tax Form 17 found here. This form allows someone to be exempt from the 50:50 split and it would fall back to the proportions relative to the share of the property each person owns like in a joint partnership.

A married couple who split rental income

What happens when they sell the property?

If one half of a civil partnership doesn’t want to sell but the other does, there is nothing that can be done under the law to evict or get rid of the person who wants to stay there.

Unless there is an exclusion order that has manifested from a divorce or for the protection of someone like if there was domestic violence, married couples and civil partners are treated as one entity.

However, if the selling of a property is amicable and agreed upon between both parties, then capital gains tax is taxed to both people and the sale of the house is split 50:50.

If you’re uncomfortable with the splitting in this way, you could look for alternatives to property investment that don’t allow you to split your income 50:50

In conclusion

Again, this article isn’t offering tax advice or legal guidance but there is a range of things involved with rental income under the law as discussed. Rental income is such an integral part of the property business that analysing the topic in detail is something all landlords should do to gain an advantage in a competitive rental market.

Monitoring this figure is a great first step to making sure any property investments pay off into the future so you can be sure you’re getting paid alongside alternative property investments and your pension.

This article has been written for information purposes only and in no way offers tax advice or legal guidance.

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donnell-bailey

Donnell Bailey

Property expert

Donnell is a property expert focusing on the property market, he looks at a combination of legislation, information from property managers, letting agents and market trends to produce information to help landlords.

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