If you are an owner of a property investment business, you must understand your tax obligations. You are required to pay income tax on rent per property. Many people, however, get confused about the actual amount they should pay, or how it is calculated. This is especially common among newcomers to the property investment business. It is important to pay your income tax accurately and as at when due, otherwise it could come back to overwhelm you later.
This article will guide you on how to calculate your income tax on rentals. So, if you are a newbie in the rental property business, consider reviewing your finances in your rental business portfolio with the following information.
Taxes on income earned is a norm
It is the law to pay a tax on all your earnings. It may not sound pretty, but it is the deal with taxes. As a rental property business owner, you will pay a tax on the rentals you receive. Recently, the UK made some changes to its property tax relief, which didn’t go down well with many in the niche. Fortunately, there are still legitimate ways to reduce your tax bill.
How rental income tax is calculated
The income tax you pay on your rented properties is simply a percentage of your profit. This is the amount left after you have calculated your total rental income and subtracted any allowances or expenses. If you have a mortgage on the property leased out, you can add the mortgage interest incurred as an expense for 2016-2017 tax year. However, the tax year for 2017-2018 will change so see a guide.
What constitutes rental income?
Your income is the main rent you receive, but may also include additional payments made by your tenants for the ‘services’ you provide. They are:
- Cleaning the communal area
- Utility expenses such as hot water, broadband services, power, heating
- Conducting repairs on the property
If there are any non-refundable deposits charged to your property, they will also be considered rental income. The same goes for money that is paid as refundable deposit at the end of the tenure.
What rental income is taxed? A hypothetical situation
For instance, if anyone is charging £700 as rent each month, inclusive of bills, they would have to acknowledge the total sum as income (though, some of these costs could be labelled as expenses). If by the end of the tenure, the tenant agrees to forfeit £450 of the deposit to make up for repairs to the property, this would be regarded as rental income. Although the rent at the end of the year would be £8,400, the landlord will be expected to declare £8,850 as their annual rental income.
Various tax bands for rental income
Rental profits in the UK are taxed in the same rates as the income a person earns from the workplace or business. That is 0%, 20%, 40% or 45%, based on the tax band the income is classified under. Your rental income will be added to any other income you earn, which could bump you up into a higher tax category. For instance:
- You earn £38,000 per annum at work
- You make a profit of £8,000 from rents received
- This bumps you above the £45,000 threshold for high tax rate (in 2017-2018 tax year)
- You will therefore be required to pay 40% on the excess £5,000
For more information on rental income please see this government guide.