The are a few different types of letting business, each has its own rules, these are:
It is likely that your property business will be within one of the categories above.
Lets look at each one in turn.
Residential Property
This is probably the most common type of property for a rental business. Mostly, held by individuals.
Tax on residential property is based on the profit made on the property before deduction of mortgage interest.
From April 2017, it is no longer allowed to deduct mortgage interest from the rent received. Instead relief is given by way of a ‘tax reducer’.
For example if you have rental income of £10,000 with costs of £2,000 and mortgage interest paid of £2,500 the net profit is £10,000 less £2,000 of costs giving a profit of £8,000.
The tax is calculated at the taxpayers marginal rate of tax, which will be 20%, 40% or 45% depending on their other income.
The tax due is as follows:
20% basic rate tax, £8,000 @ 20% = £1,600 less tax reduction for finance costs £2,500 @ 20% = £500 total tax due £1,100
40% higher rate tax, £8,000 @ 40% = £3,200 less tax reduction for finance costs £2,500 @ 20% = £500 total tax due £2,700
45% additional rate tax, £8,000 @ 45% = £3,600 less tax reduction for finance costs £2,500 @ 20% = £500 total tax due £3,100
The rate at which the tax reduction is given stays at 20% regardless of what rate of tax you pay.
Losses:
Should you make a loss on your rental property then it will carry forward to the following tax year and be set off against any profit.
In the event there is a loss the following year, then the prior year loss is rolled forward and added to the following years loss and carried forward.
Regard to mortgage interest/finance costs, these too are rolled forward until there is a taxable profit at which point the interest will be used to reduce any future tax.
It is important to note that the amount of interest used as a tax reducer is restricted to the amount of profit from the rental property.
For example, if you have mortgage interest of £4,000 and a net profit on rental income of £2,000. Then only £2,000 of interest can be used as a tax reducer, the remaining unused £2,000 is then carried forward to the following tax year.
Expenses and losses
Unlike a regular business, you cannot claim the initial cost of any equipment for a residential letting property. You can claim the cost of repairs and also the cost of renewing any items, (less the residual value of the items to be replaced).
Losses can only be used against future profits in the same property business, if you have a separate holiday letting business, you cannot offset losses from your residential property business against the holiday let business.
Note, that a residential property business outside of the UK is a separate business to UK residential property and losses from one cannot be used against the other.
Furnished Holiday Lets (FHL’s)
The FHL business has grown significantly since the pandemic, with better tax incentives than residential rentals, investors have been buying up property for FHL or changing the use of residential property to FHL.
For a property to qualify as a FHL it must be available to let for at least 210 days a year.
It must be let out commercially for 105 days, a period of rental must not exceed 31 days to the same occupier.
If you let the property to friends or family for zero or reduced rates then those days do not count towards the 105 day count for letting.
Should you own more than one FHL you are able to average the let days between the properties so if one is let for 95 days and the other 115 days, you can add the days together and average them between the properties, in this instance giving both 105 days each.
Tax on FHL’s
The tax due on profit for FHL is the same as for residential letting, you will pay tax on profit at whatever your normal rate of tax is.
However, there are some important differences in the way in which profit is calculated.
You can deduct mortgage interest from rental income to arrive at taxable profit, this has a significant advantage over residential property as the relief you receive is at your marginal rate of tax rather than 20%.
The other major difference are capital allowances, these are given as a form of depreciation against the cost of items in the property, such as furnishings, white goods, soft furnishings etc. In the year items are purchased you may use the Annual Investment Allowance, this means that the total costs can be claimed as a deduction for tax purposes. This reduction is given via the tax return and not as a deduction in the accounts.
Capital allowance may well be available for other installations in the building, for example, heating systems, electrical systems and other plant and machinery built into the fabric of the building.
This is a very complex area, please contact us for more information.
Losses incurred can only be used against profits in the same business, there is no longer the facility to move losses sideways against other income.
IMPORTANT CHANGES COMING:
In the March 2024 Budget, it was announced that the special rules afforded to FHL businesses will be withdrawn from 1st April 2025. Instead, the same rules apply to FHL businesses as to residential lettings.
There are huge implications not just from an income tax perspective but also Capital Gains. An FHL disposal would attract Business Asset Disposal relief meaning that the gain would be taxed at just 10%. However, with the removal of FHL status the gains will be taxed at the normal rates for property disposal, 18% basic rate and 24% higher rate, (note these rates start on 6th April 2024).
Speak to Howe Bridge Consulting in how we can help you mitigate the changes coming into force from April 2025.
Commercial Property
Commercial property is fairly popular as property investment.
One of the advantages is that you can deduct loan interest on the property from rent, unlike residential property there is no restriction.
As with FHL businesses there may be scope for Capital Allowances, whoever, bear in mind a tenant that holds a beneficial interest in the property, i.e. a lease (long or short), then the tenant can claimed capital allowances on any integral fixtures they add to the property.
Special care and agreement with the tenants needs to be established.
Mixed use property
A mixed use property is one comprising of both commercial and residential use, for example a building block with shops on the ground floor and apartments above.
Basically, you need to keep the accounting and tax for the commercial lets separately and identifiable from the residential lettings due to the different tax treatments of each type of use.
Overseas property
The mechanics of how overseas property mirror that of UK property the same rules apply.
However, a UK property business is a separate business to overseas property and must be treated as such. It goes further than this also, if you have overseas property in your own name and also own other overseas property in joint names then the sole properties must be treated separately to the joint lettings.
This results in losses arising from one business being locked into the business, they cannot be offset against profits of any other property business.
Special care needs to be taken when accounting for a property business that incorporates a mix of any or all of the above types of property business.
Contact us today for expert property tax advice.