With interest rates remaining low, many people are turning to property as an investment and this month we look at the tax implications of renting out property.

The renting of property – whether one property or several – is treated as a “property business”.

The profit or loss of a property business is calculated essentially in the same way as that of a trade. Profits will normally be computed on a tax-year basis, to 5 April each year. The amount of rental income to be included is the amount receivable for the tax year, which may not be the same as the amount actually received.

The expenses which can be deducted are those which are incurred by the landlord “wholly and exclusively” in relation to the letting, i.e. letting agent’s fees, management charges, service charges, repairs, mortgage interest, insurance, accountancy fees, utilities (where paid by the landlord). Where rent due is not received, bad debt relief can be claimed. The cost of capital improvements made to a property – i.e. the cost of a new kitchen or extension – cannot be claimed, tax relief is given on these costs when the property is eventually sold, by deducting them from the sale proceeds.

Where a property is let furnished, the landlord will incur additional costs of furniture and furnishings. These costs can be dealt with in one of two ways – the actual costs can be deducted in the year they are incurred or alternatively the landlord can claim an annual “wear and tear allowance”. The wear and tear allowance is intended to cover the cost of renewing the furniture or furnishings that tenants would provide for themselves if the accommodation was let unfurnished, including furniture, linen, crockery, cutlery, cookers, washing machines, dishwashers etc. Where the allowance is claimed, no further deduction is available for the cost of such items. However, the cost of renewing fixtures which are an integral part of the building (e.g. baths, toilets, washbasins) can still be claimed, provided they are replacements and not capital improvements.

The wear and tear allowance is calculated as 10% x (A – B) where A equals rents receivable and B equals tenant’s expenses – tenant’s expenses are those expenses which, although borne by the landlord, relate to utilities, council tax or any other expense which are normally paid for by the lessee.

Income and expenses from all properties within the “property business” are aggregated and declared on the individual’s tax return for the tax year in question. A profit is taxable income of the tax year; a loss is carried forward and set against future profits from the property business.

Although profits are computed similarly to those of a trade, the income remains investment income. However, profits from properties which qualify as “furnished holiday lettings” are treated as trading profits. A property qualifies as a furnished holiday letting (FHL) if:

(a)     it is available for commercial letting to the public generally as holiday accommodation for at least 210 days in a twelve-month period (generally a tax year); and

(b)     is so let for at least 105 such days (averaging may be applied to the number of let days of any or all of the holiday accommodation let by the same person).

Wear and tear allowance is not available on FHLs – instead, capital allowances can be claimed on furniture and furnishings as well as on plant and machinery used outside the property.

One of the main tax advantages of FHLs has been removed, in that since 2011/12, a loss on FHLs can no longer be set against the landlord’s general income for the same tax year but must be carried forward against future profits of the FHLs.

However FHL profits are treated as “relevant earnings” for the purposes of tax relief for pension contributions and the capital gains tax reliefs available on the sale of a trade also apply on the sale of an FHL – such as Entrepreneur’s Relief, which reduces the rate of tax payable on a gain on sale to 10%.

A final area to look at is the rental to lodgers of furnished rooms in an individual’s own home. Where total rental receipts from lodgers in an individual’s own home in a tax year do not exceed £4250, the income is exempt from tax.

If the rent exceeds this amount then the individual’s taxable rental profit can be computed in one of two ways – the individual is either taxed as normal on rental income less allowable expenses or an election can be made such that only the excess income over £4250 is taxable (with no deduction for expenses). The election then applies to future years unless it is withdrawn.