Calculating tax if you are a residential property landlord.

In this week's post, I would like to help you understand the process of calculating your tax if you rent a property. For the purpose of this post I will be talking about renting residential property, otherwise described by HMRC as a 'dwelling house' - that is a property, or part of a property which is a self-contained unit of accommodation, for living purposes eg. house, flat or a single room, which is treated as a home. That means I will not be talking about renting a furnished holiday letting or commercial property.

Calculating your tax if you are renting out a property might seem daunting, but it is really quite easy and can be explained in 5 simple steps. You have to remember, that like all income tax, you shouldn't calculate the property income tax separately from your other income. In order to accurately calculate your tax, you need to take into consideration four categories of income together. The categories are Property Income, Trading Income, Savings and Investment Income and Employment, Pension and Social Security Income. Only after calculating your income from all four categories, can you find out in which tax band you are and calculate your tax accordingly.

Another important thing to keep in mind is that you need to let HMRC know about your property income by the 5th of October following the end of the financial year in which you had taxable property income.

Let's begin with calculating our rental income for tax purposes.

1. What is the total rent I have received for one financial year?

Simply calculate all rents that you have received on all your properties within one financial year. If the sum is less than £1000 you don't need to do anything. This is your tax-free income. if you have received more than £1000 but less than £2500 you need to let HMRC know and they will tell you if you need to report this income in self-assessment. If you have received more than £2500, you need to calculate all your deductible expenses. If your income after deductible expenses is more than £2500 an up to £9999 you need to report this income in self-assessment. You always need to report your property income in self-assessment if the amount you receive in rent is more than 10,000 pounds, regardless of the level of your expenses. If you are renting out a room in your home, your tax-free allowance is £7500.

2. What are my total allowable expenses?

Allowable expenses are expenses that you can deduct from your rental income, to calculate the taxable rental income. These are expenses that you have paid for, wholly and exclusively for purposes of letting out a property. Typical examples would be renovation and repairs - but not an improvement of property, water rates, council tax, gas and electricity if you are paying them, insurance, letting agents, legal and accountant's fees, advertising for new tenants, etc.

Allowable expenses do not include mortgage payments, and not even mortgage interest. You can however offset a part of your mortgage interest against your tax, once you have calculated it. We will look at it in step number 5.

A list of examples of allowable deductions can be found on HMRC's website.

3. What are my allowances?

One allowance that you should be aware of is an allowance for replacement of domestic items, otherwise known as Replacement Domestic Items Relief. This allowance lets you deduct the expense of replacing an old domestic item like a couch, fridge or even curtains.

Another allowance you might want to know about if you own a House of Multiple Occupation or a block of flats is a Capital Allowance. Capital allowance can be claimed against 'plant and machinery' capital expenditure which is not for use in a dwelling house. This means you could claim the capital allowance, for the cost of fitting an elevator in a block of flats or improvement works in the common area of a House of Multiple Occupation.

I will write about Replacement Domestic Items Relief and Capital Allowances in more detail in the near future, so stay tuned.

If all your allowable expenses and all your allowances together are less then £1000, you can claim your tax-free allowance of £1000 to set off against your property income instead.

4. What is all my other income?

Now you need to add your other taxable income. Take into consideration any other income you receive, be it salary, trading, pension, etc, but not savings and dividend income. Add all this income together so that you can calculate tax on your general income.

5. What is my tax relief?

Now it's time to calculate your tax relief for residential landlords. This tax relief is calculated based on the smaller of three amounts:

• Your finance cost (eg. mortgage interest)

• Property business profit ( your property income after all allowable expenses and brought forward losses)

• Adjusted total income - this is your income( after losses and other reliefs deducted, and before adding savings and dividends income) which exceeds your personal allowance.

Tax relief is calculated using the Basic Tax Rate value. Currently, the Basic Tax Rate is 20%

Your tax relief for residential landlords will be 20% of the lower of the three above figures.

Deduct your tax relief from the tax you have calculated in step 4. This is your general income tax, including your property rental income tax.