Taxation of Property Income

The principles surrounding the taxation of property income held personally are broadly similar to that of other types of income, but there are differences, particularly if this is your first period with letting income. The rules are different for properties held via companies. For more information on using a company, please see our article here.

The taxation rules vary depending on whether the property income is Residential, a Furnished Holiday Let (FHL) or Commercial. For more information on these different types, please see our article here.

What expenses can I claim?

An expense must be wholly and exclusively for the business. If you had incurred the expense anyway, it would not be allowable as an expense. If there is a dual purpose, a proportion of the cost may be allowable, especially if the landlord lives in a part of the property they also let.

Property repairs, agent fees, ground rents, energy certificates, and mileage to and from the property are among the various expenses that may be claimed. Finance costs such as mortgage interest are more complex and are discussed further below. There are also special rules for things deemed to be domestic items which include furniture, kitchen appliances, carpets and other furnishings. If this is your first let, you should carefully read the pre-let rules in this article.

Expenses that are capital in nature are not deductible for residential property income. Instead, they are set aside to be deducted against any future gain when the property is sold. FHL and commercial properties may be able to claim capital allowances.

Capital v Revenue expenses

The distinction between Capital and Revenue expenditure is not always clear and is best explained with some examples.

A garage conversion or a new conservatory is capital in nature. Replacing a basic kitchen with a significant upgrade would also be capital. Replacing a basic kitchen that is a like-for-like would be classified as a repair.

Replacing a wooden fence with a wall would be capital. Still, if there was no fence before, HMRC could contend that it is also capital in nature.

An expense will usually be treated as a repair if it is a like-for-like replacement. Where something is deemed to be a modern building standard, such as double glazing, it will be an allowable repair, assuming, in this case, there were at least single-glazed windows there before.

Houses purchased “in need of total renovation” are deemed to require capital repairs, which is reflected in the lower purchase price. This means where the repairs may have been otherwise allowable, such as a like-for-like kitchen in a habitable property, they would be disallowed here as there either wouldn’t be one there or it would be unusable.

Critically, only capital expenditure that still has value on the eventual sale will be allowable for capital gains. So the longer the period after the expense has occurred, the more likely HMRC would argue there is no remaining capital value. If you have owned the property for an extended time, some capital expenditures disallowed many years ago may also no longer be deductible when you sell the property.

Replacement of domestic items relief

This relief is only for residential property income and covers a wide variety of kitchenware, household furniture (i.e. beds, tables, carpets and curtains) and white goods appliances. It does not apply to fixtures deemed part of the house, such as toilets, baths and fitted wardrobes. Relief for these items is permitted in full for FHL and commercial lettings.

There is no relief for the initial purchase, but only for replacing an item of the same value.

If you replace a £300 washing machine with one that is £600, relief would only be given for the £300. If you replaced it again, you could get relief for one costing £600.

This means that if you supply your first property with a range of household furniture, carpets and kitchen appliances before you commence letting, they will all be disallowed as none of them are replacing anything, as the business will not yet have begun. For more information on this, please see the section below on the first year of property income.

My first year of property Income

If you already own a rental property, any additional properties are treated as one business, all expenses are pooled, and the pre-letting rules do not apply. If this is your first property, then you will need to establish when the rental business started and what expenses could be considered Pre-let. This is particularly important if you lived in the property before letting it out.

A dormant period after previously living in a property prior to letting may not be a qualifying period of expense and would be treated differently to a property purchased solely as a buy-to-let. Council tax, gas, and electric costs incurred after vacating the property with the intention of finding a tenant would be an allowable pre-let expense.

Your start date is usually when letting commences – typically when the tenant moves in. Pre-let expenses can be claimed if the expense would otherwise have been allowable had it been incurred after the rental business had started, up to a maximum of 7 years. In most cases, expenditures that occurred while the owner was still living in the property would likely fail the wholly and exclusively test.

Redecorating after moving out before the tenant moves in a few weeks later would be allowable as a repair pre-let expense. Buying new furniture and kitchen appliances before renting starts would not be allowable as a pre-let expense as the replacement of domestic items relief can only replace existing items in a rental business, which is not possible if the business has not yet commenced.

This means that for a first property, it is often tax efficient to incur expenses after the tenant has already moved in.

Finance costs

HMRC has detailed guidance on how finance costs are dealt with and includes both re-mortgage charges as well as interest. They are disallowed for residential property income as an expense, and relief is given back via a 20% credit against any tax due on the property income. They are allowable in full for FHL and commercial lettings.

This means if you are a basic rate taxpayer, you will get relief in full. If you are a higher-rate taxpayer, you will only get around half. The implications for landlords with properties with low rental income and high mortgage interest payments can be punitive, as a higher rate taxpayer may end up paying more in tax than they actually make in profit. For example, a landlord who is an additional rate taxpayer making £10k in rental receipts with £10k in mortgage interest would technically have no profits but would still be on the receiving end of a £2,500 tax bill.

Joint tenants or tenants in common
It is important to understand what type of ownership you will have before you buy. In both cases the names will appear on the title deeds, but when a joint tenant dies the property passes to the surviving owner regardless of their will under what is called “the right of survivorship”.

People who are investing as business partners or have children from a previous relationship are likely to want to retain ownership for their families on death and should discuss being tenants in common with a solicitor.

Taxation

Property income in England and Wales is taxed at your marginal rate as follows:

Basic rate – 20%

Higher rate – 40%

Additional rate – 45%

If you own a property jointly with a spouse, you must ordinarily split the profits 50:50. If you are married/civil partnership and believe you should have a different allocation due to a different capital input, you will likely need to obtain a declaration of Trust from a lawyer and register this with HMRC on form 17 within 60 days. There is no capital gains tax on transfers if you are married. You should ensure that your legal ownership is that of a tenants in common (see above) rather than joint tenants. This is usually a permanent exercise and will remain in place until the property ownership changes. 

If you are unmarried and jointly own a property, a lawyer can draft a severance of joint ownership which you can file with the land registry and use the new % split; however, any transfer of value would trigger a CGT event. If you do not jointly own the property, it will be taxed on your % capital input.

If you own the property with others who are not your spouse, such as siblings, you may use any agreed profit split.

Property allowance

If you have very few property expenses, you may claim the £1,000 property allowance instead of using actual expenses against your income. If you rent out your driveway or garage, this may be useful.

Rent a room scheme

This is a £7,500 allowance that can be used instead of expenses (whichever is higher) and is divided up if there are multiple owners living in the house. If your rental income is £8,500 and you own the property jointly with your spouse, you would have £8,500-£7,500 = £1,000 profits = £500 taxable each of rental profits to declare on your tax returns.

Record Keeping

We encourage the use of a business bank account for your rental income and expenses as this keeps it tidy and helps prevent any overlap with expenses and income from your personal home. If you are using Freeagent Landlord and using the bank feed option, you can attach any necessary invoices and receipts to the software.

All records and receipts of income and expenses should be retained for a minimum of 22 months following the end of the tax year. These may be in digital format and retained within the software. So for a tax year ending 5 April 2023, the minimum time period would be until at least 31 January 2025. For a company, records must be kept for 6 years.