Tax on rental income: how HMRC says it works

HMRC says you pay tax on the profit you make from renting out property, not on the rent itself. Profit is your rental income minus the expenses or allowances you can claim. The guidance also explains what counts as rental income, what you can and cannot deduct, and what records you must keep.

What counts as rental income for tax?

HMRC defines rental income as the rent you get from your tenants. The guidance also lists other payments that count as rental income, where tenants pay you for things connected to the letting.

According to HMRC, rental income includes payments for:

• the use of furniture
• additional services you provide, including cleaning of communal areas, hot water, heating and repairs to the property

This matters because those extra payments can increase the figure you start with when working out your taxable rental profit.

How is tax on rental income worked out (profit, not rent)?

HMRC is clear that the tax charge is based on profit. It also explains, in plain terms, how to get to that profit figure.

• Step 1: add up your rental income.
• Step 2: take off the expenses you can claim, or any allowance you choose to use (where the guidance allows it).
• Result: what is left is your profit (or a loss).

HMRC also says that how much tax you pay depends on how much profit you make and your personal circumstances.

If I rent out more than one property, do I add the profits together?

HMRC treats this as one property business figure in many cases. If you rent out more than one property, HMRC says the profits and losses are added together to arrive at one figure of profit or loss for your property business.

HMRC also draws a line between UK and overseas property. It says profits and losses from overseas properties must be kept separate from properties in the UK.

Joint ownership: who pays tax on the rental income?

HMRC says that if you share ownership of rental property, the amount of rental income you pay tax on depends on your share of the property. It also explains how this usually works if you jointly own with a spouse or civil partner, and what may happen if ownership or income shares are unequal.

Jointly owned with a spouse or civil partner

HMRC says property jointly owned by married couples and civil partners who live together will usually be taxed in equal shares.

It also says that if you own the property in unequal shares and are entitled to the income in the same unequal shares, the income can be taxed on that basis. HMRC adds that you both need to declare beneficial interests in joint property and income.

Jointly owned with someone else

HMRC says that if you own a property jointly with another person who is not your spouse or civil partner, your share of the rental profits or losses will usually be based on the share of the property you own, unless you agree a different allocation.

What rental expenses can I deduct (and what can I not claim)?

HMRC says you can deduct expenses from your rental income when you work out your taxable rental profit, as long as they are wholly and exclusively for the purposes of renting out the property. The guidance then gives examples of expenses you can deduct and expenses you cannot claim a deduction for.

Examples of expenses HMRC says you can deduct

HMRC lists these as examples of expenses you can deduct if you pay for them yourself:

• general maintenance and repairs to the property
• water rates, council tax, gas and electricity
• insurance, such as landlords’ policies for buildings, contents and public liability
• costs of services, including the wages of gardeners and cleaners
• letting agent fees and management fees
• legal fees for lets of a year or less, or for renewing a lease for less than 50 years
• accountant’s fees
• rents (if you’re sub-letting), ground rents and service charges
• direct costs such as phone calls, stationery and advertising for new tenants
• vehicle running costs (only the proportion used for your rental business) including mileage rate deductions for business motoring costs

HMRC also says you can claim expenses for the interest on a mortgage to buy a non-residential let property.

Examples of expenses HMRC says you cannot deduct

HMRC lists examples of expenses you cannot claim a deduction for. These include enhancements or improvements (capital expenditure), the full amount of your mortgage payment (only the interest element can be offset against your income), private telephone calls (only the cost of calls relating to your property rental business), clothing (with an example of buying a suit), and personal expenses.

Claiming part expenses (where something is mixed use)

HMRC explains that where only part of an expense is for your property rental business, you can deduct that part as long as it is wholly and exclusively for the property business.

Repairs, replacements and improvements: what does HMRC treat as allowable?

Confusion often comes from the difference between a repair (usually allowable as an expense) and an improvement (often described in the guidance as capital expenditure). HMRC gives practical descriptions and examples.

Maintenance and repairs

HMRC says allowable expenses include the costs of maintenance and repairs to the property (but not ‘capital’ improvements). It says a repair restores an asset to its original condition, sometimes by replacing parts of it.

HMRC examples of property repairs include:

• replacing roof tiles blown off by a storm
• replacing a broken-down boiler
• redecoration between tenants to restore the property to its original condition

HMRC also says replacing a part of the property with the nearest modern equivalent is still a repair if the improvement is incidental to the repair, giving the example of replacing a single-glazed window with a double-glazed window.

If your insurance covers some repairs, HMRC says you can only claim the additional expenses you incurred for repairs which the insurance pay-out did not cover. It says this also applies if you keep your tenant’s deposit from a tenancy deposit scheme to cover damage, and you can only claim expenses incurred for repairs in excess of the amount of the deposit that you kept.

Replacing furnishings and domestic items

HMRC says you cannot claim the costs for replacing furnishings or equipment in a property as maintenance and repairs. However, the guidance says that from 6 April 2016 they may qualify for replacement of domestic items relief.

HMRC says that if you let out residential property (a dwelling house) you may be able to claim a deduction for the cost of replacing domestic items such as movable furniture, furnishings, household appliances and kitchenware.

HMRC says replacement of domestic items relief is only available for expenses incurred from 6 April 2016 for Income Tax purposes. It also says you cannot claim this relief if you are renting a room in your home, or for the initial cost of buying domestic items for a dwelling house.

Where the new item is an improvement on the old item, HMRC says you can only claim a deduction for the cost of buying an item the same as the original. The guidance provides an example using £400 and £550 to show that only £400 is deductible and no relief is available for the £150.

Capital expenditure (improvements and upgrades)

HMRC says expenses are ‘capital expenses’ if they will be used in the business over a longer period of time. It gives examples such as adding something to the property that was not there before, altering, improving or upgrading something that was existing, and including the purchase of furnishings and equipment for the property.

HMRC says capital expenses are not allowable and cannot be claimed against your rental income, but you should keep records of them as you might be able to set them against Capital Gains Tax if you sell the property in the future. HMRC examples of capital expenses that would not normally be allowable include adding an extension, installing a security system if there was not one before, and replacing a kitchen with one of a higher specification.

Mortgage interest and finance costs: what does HMRC say changed?

HMRC’s guidance includes a section called “Changes to tax relief for residential property”. It says that from 6 April 2020 Income Tax relief on all residential property finance costs is restricted to the basic rate of Income Tax.

It also sets out who is affected, who is not affected, and what counts as “finance costs restricted”. HMRC lists interest on mortgages, loans (including loans to buy furnishings) and overdrafts, and it also lists other costs affected such as fees and incidental costs for getting or repaying mortgages and loans.

If a loan is for both residential and commercial properties, HMRC says you will need to use a reasonable apportionment of the interest to work out your finance costs for the residential properties, because only the residential properties’ finance costs are restricted. It says this also applies if your loan was partly for a self-employed trade and partly for residential property.

HMRC also has a section on increasing your mortgage. It says you may be able to treat interest on the additional loan as a revenue expense, or get relief against Income Tax, as long as the additional loan is wholly and exclusively for the purposes of the letting business. It adds that interest on any additional borrowing above the capital value of the property when it was brought into your letting business is not tax deductible.

Property allowance and cash basis: are there simpler options?

HMRC mentions two ideas that can make reporting and record keeping feel simpler in some situations, the property allowance and cash basis accounting. They are not the same thing and the guidance sets different conditions for each.

Property allowance

HMRC says you can claim the property allowance and get up to £1,000 a year tax-free property income. It also says that if you claim the property allowance you cannot claim a deduction for your expenses.

Cash basis accounting

HMRC describes cash basis accounting as a simpler way of working out taxable profits for businesses with straightforward tax affairs. It says if you have income from a property business you will be able to use ‘cash basis’ rather than standard accounting to work out your taxable profits.

HMRC also says that if you meet the criteria but do not want to use the cash basis and prefer to use standard accounting methods, you must check the box on your return to opt-out of the cash basis.

What records do landlords need to keep, and for how long?

HMRC says you will have to keep accurate records of rent received and your expenses incurred to work out the profit you will pay tax on. It also says your records must separate your income from fully-furnished lettings and unfurnished or part-furnished lettings.

The guidance gives examples of the kinds of records you should keep, including rent books, receipts, invoices, bank statements and mileage logs (for journeys that are solely for your property business purposes).

HMRC also gives a specific minimum retention period. It says you must keep your records for at least 5 years after the 31 January tax return deadline for each tax year.

Finally, HMRC warns that it can charge you a penalty if your records are not accurate, complete and readable, or if you do not keep them for the required period of time. It also says you may have to pay a penalty if you submit an inaccurate tax return, and that it may check your records to make sure you are paying the right amount of tax.

If you manage more than one property, tracking income, expenses and documents in one place can make the year end work calmer.