Property Rental Income and Tax - Unfurnished

Letting Unfurnished Property - Tax Overview

People who let a small number of unfurnished non-holiday properties in the UK (eg. 2 or 3) will normally be regarded as investing in the properties, rather than carrying out a business.

They would therefore not be regarded as being self-employed, but would still be required to complete a Self Assessment and complete the 'Income from Property' section.

When Letting Becomes Trading

When the portfolio of properties increases, and properties are typically bought, renovated and then sold, then HMRC will regard this as trading, and therefore self-employment.

Income Tax and Self-Assessment

There is a separate section on the Self Assessment tax return form (including the online version) for property letting income and related expenses.

There are very specific tax regulations for property letting:
GOV.UK: Income Tax when you let property: work out your rental income

Class 4 National Insurance

If the properties are regarded as investments (ie. not trading) then Class 4 National Insurance would not normally be expected to be payable.

If the property business is regarded as trading, then Class 4 NI would normally be payable.

Class 2 National Insurance

Class 2 National Insurance is a more contentious issue in relation to properties; the HMRC guidance is less clear. Class 2 NI does not necessarily follow Class 4 NI.

However, normally, if the properties are regarded as investments then Class 2 NI would not normally be expected to be payable.

If the property business is regarded as trading, then Class 2 NI would normally be payable.

Expenses

When letting has commenced, Expenses which are directly related to running the property would normally be claimable against the income from the property, in order to calculate the taxable profit.

It cannot be assumed that 'everything is allowable', the regulations are very specific.

Examples of routine allowable Expenses after letting has commenced are: utilities, repairs, cleaning, management fees, advertising, accounting & bookkeeping fees and insurance.

Travel directly to and from the property, as part of managing the property, would also normally be allowed. This claim is not allowed if other private activities were part of the same journey, unless they were 'incidental'. 'Incidental' would include stopping to a buy a bottle of milk, but not a large supermarket shopping activity.

It may also be possible to claim for the use of your home, for example, for the time spent on paperwork.

Mortgage Interest Relief

There was a major change in the tax regulations with regard to tax relief for mortgage interest which took effect from tax year 2017/18.

GOV.UK: Restricting finance cost relief for individual landlords - Who is likely to be affected

GOV.UK: Changes to tax relief for residential landlords

This change could cost higher tax rate landlords several thousand pounds in lost tax relief, depending on the number of properties and the mortgage interest being paid.

For this reason, some landlords are moving to a Limited Company basis, but limited company tax is also undergoing some changes, particularly for Dividends.

Repair or Renovation?

Generally, if a property is dilapidated and needs some improvement prior to tenants moving in, the money spent after purchase, but before occupancy, is not generally classified as repairs and is therefore not an expense for the Income Tax calculation.

It is not a repair if there is a significant improvement of the asset beyond its original condition.

Improvement costs to a dilapidated property are added to the original cost of the property. The combined original purchase and renovation costs are used for the Capital Gains Tax (CGT) calculation, if and when the property is sold. An exception is that free standing 'white goods' and other non-fixed items are not counted as renovation costs for CGT.

The time when the first tenant moves in is not definitively the point when improvement stops and any repairs start. On-going improvement costs might well be considered by HMRC to be renovation and not repair.

For example, a bathroom refit after 10 years, will usually be allowed as an expense if there was no significant enhancement. However, if there was a significant enhancement, eg. to a 'wet room', then this will probably be regarded as capital - ie. an addition to the cost of the property, and not an expense against letting income.

Another example would be significant enhancements in line with modern building materials, health & safety and energy efficiency which would be allowed as an expense and not capital, for example fitting double glazing.

If capital improvement and repairs are carried out at the same time and alongside each other, then the expenditure could be apportioned on a reasonable basis.

GOV.UK: Property Income Manual - Repairs and Capital

GOV.UK: Business Income Manual - Repairs and Capital

Legal and Professional Fees

Fees incurred in acquiring a property are normally capital, for example solictors and surveyors.

Such expenses for the first letting of a property for a lease of more than one year are capital expenditure. Expenses for a let of a year or less can be treated as Expenses.

GOV.UK: Property Income Manual - Legal & Professional Costs

Expenses Incurred Prior to Letting

Whilst there are some restrictions, eg. capital and legal & professional fees (see above), Expenses incurred within a period of 7 years before the date the rental business started are allowed to be claimed against tax.

The main condition is that the Expenses would have been allowed as a deduction if it had been incurred after the rental business started.

Pre-letting Expenses are treated as incurred on the day the rental business commenced - that is, the first letting day.

GOV.UK: Property Income Manual - Beginning and End of a Rental Business: Commencement

Income Split: Is It Always 50/50?

Not necessarily.

If a married couple or a civil partnership "Jointly" own a property ("Jointly" being a legal definition), HMRC will treat the beneficial ownership as 50/50 by default (ITA 2007, Section 836). If the married couple or civil partners require a different proportion each, say 80/20, this is possible by preparing legal documents to change the beneficial ownership. This is permitted by ITA 2007, Section 837.

A change in beneficial ownership is an acquisition by one person and a disposal by the other, so Capital Gains Tax could potentially be a factor at the time of change or some further disposal point in the future. Transfers of assets (outright gifts) between spouses or civil partners are nil gain / loss (TCGA 1992, Section 58).

For an ITA 2007, Section 837 election, it will be necessary to change the ownership to "Tenants in Common". Also, because the actual share of a property (as tenants in common) is not on the title deeds, the new revised share should be recorded by a "Declaration of Trust", signed by the parties and recorded at the Land Registry. HMRC are then informed of this change using Form 17.

The Form 17 does not change anything, it is just the method of informing HMRC. Form 17 must be submitted with 60 days of the "Declaration of Trust".

A Section 837 election can only be made where the beneficial interests in the income and capital are the same.

A married couple or a civil partnership can choose a different split for each property.

A Section 837 election is not permitted for partnership income and income from furnished holiday lettings.

If a property is owned jointly by two people who are not married or in a civil partnership, then the property income and profit can be split however they agree, and this split must be consistent with what they submit to HMRC. The share of income and profit need not be the same as the equity/ownership share. The HMRC document which covers this PIM 1030. As of March 2014, HMRC do not offer further guidance on what reasons someone may have for choosing this arrangement, or how often the share percentages may change. Having the agreement in writing would be advisable.

We recommend that a solicitor is engaged for the Declaration of Trust, and the Land Registry changes.

Furnished Property

There are specific HMRC regulations in relation to Furnished Property.

Holiday Lettings

There are specific HMRC regulations in relation to Holiday Lettings.

HMRC Information

The HMRC GOV.UK: Property Rental Toolkit contains lots of detailed information and guidance.

Other HMRC Links:

GOV.UK: Property Income Manual TEXT