How To Avoid Paying Tax On Rental Income

Taxes are a certainty in life, although you can legally reduce your tax obligations by making some smart choices with your property investments. Understanding the taxes you have to pay from your rental income and how you can offset them or claim reliefs can reduce your tax bill, leaving more money in your pocket.

Table of Contents

What Taxes Do You Need to Pay as a Landlord?
What Can You Offset Against Tax On Rental Income?
Ways To Reduce Your Tax Obligations on Rental Income
What Happens if You Don’t Declare Your Rental Income?

What Taxes Do You Need to Pay as a Landlord?

When you buy and sell property, you may have to pay Stamp Duty Land Tax (SDLT) or Capital Gains Tax. However, you have to pay income tax on your regular rental income just like anyone else with regular earnings. The first £1,000 of income from property rental is tax-free, and you do not need to declare it. If you earn more than this, you should declare it to HMRC even if your tax rate is zero. If you are self-employed as a landlord, you can declare your earnings on the HMRC website, calculate your tax bill and pay online, or have your accountant do this for you. If you own and let property through a limited company, then you will pay corporation tax rather than income tax.

FAQ: How do I pay National Insurance as a landlord?

If you earn enough to pay taxes (i.e. More than £12,570 per year), you pay Class 4 National Insurance. This is 6% on profits from £12,570 – £50,270, and 2% on profits over £50,270. If your profits are below the minimum for taxes, but over £6,725 per year, you can make voluntary Class 2 NI payments, making sure you can qualify for a state pension later in life. You can pay National Insurance at the same time as paying your taxes.

What Can You Offset Against Tax On Rental Income?

When calculating your net income, always remember to include all expenses to avoid overpaying on your tax bill. As well as obvious costs such as property maintenance and repairs, replacing domestic items, letting agents fees, council tax and others, there are other expenses you may have missed. Here are some that could be included in your expenses:

Travel costs to and from the property
Costs of marketing and advertising, e.g. listings on property websites, social media ads and more
Phone calls and texts made relating to your rental property
Legal and accountant fees
Subscriptions to property investment-related magazines, products and services
Insurance
General costs of running a business, stationery, printer ink, etc

You can also offset expenses incurred during void periods that you still need to pay even though the property is empty, like council tax. It should also be noted that deposits paid by tenants should not be counted towards rental income, as the deposit should be returned to the tenant.

FAQ: Can I claim mortgage payments as an expense?

No, unfortunately, you cannot do this, although you can claim a 20% tax credit on the mortgage interest.

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Ways To Reduce Your Tax Obligations on Rental Income

Form a Partnership

If you and another party invest in a property together, then your expenses including taxes are shared. Yes, you will take home less of the profits, but your tax burden is reduced too. The profits may not be split evenly depending on your arrangement, which could be favourable for tax purposes. If you have a partner, friend or family member who is in a lower tax band than you, you can transfer some of the beneficial interest to them, i.e. giving them a financial share as a portion of the rental income and reducing your tax burden. You can do this by completing Form 17 from HMRC.

Invest in Your Property

Performing repairs and maintenance to your property is an allowable expense that you can offset against your profits, as long as they don’t qualify as capital enhancements. Capital enhancements are renovations that can add to or improve the value of the property. Replacing a fixture or fitting with a modern equivalent, or bringing an asset back to its original condition can be considered repairs, whereas adding significant value with luxury new fittings is a capital enhancement and is not deductible.

For example, replacing the windows in a property and going from single or double-glazed windows to triple-glazed windows, while it is an enhancement, is definitely a modern equivalent, as the windows already existed in the first place. Replacing a kitchen can be considered maintenance, although if you add luxury materials like marble worktops or add units, thus increasing the storage space, this could be considered a capital enhancement.

Form a Limited Company

Forming a limited company can reduce your tax obligations, especially if you are in a higher tax bracket from your rental income. As previously mentioned, limited companies pay corporation tax rather than income tax, but this is between 19% and 25%, rather than the 40% or 45% you could be paying as a self-employed landlord. Suppose you want to leave your rental properties to your family in your will. In that case, you can also avoid inheritance taxes through business property relief if they are owned by a limited company.

Carry Losses Forward

If you have made losses in previous years as a landlord, you can carry these losses forward and offset them against your profits to reduce your tax bill. You cannot offset losses against other forms of income or any capital gains, but you can offset losses made on one property against another property.

What Happens if You Don’t Declare Your Rental Income?

If you have earned money and have not paid tax on it, you should inform HMRC as soon as possible, as they may be lenient if you approach them first. If they discover you have earned rental income and not declared it, they may look less kindly upon you. HMRC can claim back up to 20 years’ worth of undeclared tax and impose fines of up to 100% of the unpaid tax. Tax evasion can even result in criminal prosecution including jail time of up to 7 years.

By being smart and making informed choices, you can reduce your tax bill without breaking any laws or doing anything that could put you at risk. I would recommend using an accountant who specialises in property businesses as they can best advise you on what route to take to minimise your tax obligations.

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