How to pay income tax on property business profits?
What does property business profit consist of?
Income from land and buildings in the UK will be liable to assessment under property income.
Rent received/receivable under any lease or tenancy agreement
The premium received on the grant of a short lease.
|Property income is assessed in the following manner:|
|Rent received/receivable in the tax year||x|
|Plus: premiums received in the tax year||x|
|Less: capital element of the premium received in the tax year||(x)|
|Less: allowable property expenses paid/payable||(x)|
|Property business profit/loss||x/(x)|
From 2019/20 the default method for the calculation of property income is the cash basis - rental income received less allowable expenses paid.
This gives automatic bad debt relief as rental income is not taxed unless it is received.
Under the accruals method, whatever income is allocated to the tax year and whatever expenses are allocated to the tax year will be taxable in that tax year.
When this income is actually received in hand or when the expenditure is actually paid out does not matter.
Rental income and allowable expenses will be assessed on an accruals basis when:
Property income receipts for the tax year exceed £150,000
The property business is carried on by a company
An election is made for the accruals basis to apply (elect by 31 January 2022 for 2019/20 tax year).
For premiums received due to grant of a short lease, the entire income element of the premium will be assessed in the tax year that it is received.
This calculation will be illustrated in Topic Premiums granted for short leases.
NOTE: in your exam you should assume that the cash basis applies unless told otherwise.
Penny owned two properties which were let out unfurnished until both properties were sold on 31 December 2019.
The following information is available in respect of the two properties:
|Property one||Property two|
|Allowable revenue expenditure||(£4,800)||(£2,500)|
What is her property business profit for?
|Revenue||£3500 + £7300 =||£10,800|
|Allowable cost||(£4,800 + £2500) =||(£7,300)|
|Property business profit||£3,500|
Anne bought a property and rented it out for the first time on 01/07/2019.
The rent of £1,000 is paid in arrears on the last day of each month. The payment for March 2020 was not received until 10 April 2020.
She paid allowable expenses of £300 in November 2019 and £500 in May 2020 for repairs that were completed in March 2020.
Calculate the property income for 2019/20 using (i) the cash basis and (ii) the accruals basis.
|(i) cash basis||(ii) accruals basis|
|Rent receivable * (1 July - 5 April)||8 x £1,000 = £8,000 (March rent was not received until after 5 April 2020).||9 x £1,000 = £9,000 (rent is accrued for the whole period from 1 July 2019 to 5 April 2020).|
|Property income assessable||£7,700||£8,200|
Note: On the cash basis the March 2020 rent was not received before the tax year end and so it is not taxed in 2019/20. The expense of £500 was not paid until after the tax year end and so it is excluded from the calculation. Both of these items will be dealt with in the tax year 2020/21.
These are expenses incurred by the landlord and reduce the taxable property business profits.
To be allowable, an expense must have been incurred wholly and exclusively in connection with the business, for example:
Other management expenses
e.g. cleaning expenses
Capital expenditure is NOT allowed, therefore repairs are allowable, however capital expenditure to improve the property are not allowed.
This differentiation can be made simpler by asking yourself whether the expenditure improved the income earning capacity of the property, if it did, it is likely to be capital expenditure.
Capital allowances may be claimed for expenditure on plant and machinery used for the maintenance of the property.
Interest on a loan to purchase a property (subject to a cap of 25% in 2019/20)
e.g. A tenant left owing 1 month’s rent which you were unable to recover
Cost of replacing windows, doors and boilers
If a landlord uses their own vehicle to travel to and from the property they can either
deduct the actual motoring costs or use the approved mileage allowance which we saw
in the Topic The authorised mileage allowances.
Replacement furniture allowance (this replaces the old wear and tear allowance and is available for all properties (except furnished holiday lets) whether fully or part furnished)
Individuals and companies deduct the actual cost of replacing furniture and furnishings when calculating the property income from renting out a residential property.
Furnishings include items such as beds, televisions, fridges and freezers, carpets and floor coverings, curtains, and crockery and cutlery.
There is no relief for the initial cost of furniture and furnishings, there is only relief when assets are replaced.
The amount of relief is reduced by any proceeds from selling the old asset which has been replaced (Replacement cost - sale proceeds = replacement furniture relief).
Also, relief is not given for any cost which represents an improvement, for example, if a washing machine is replaced with a washer-dryer, only the cost of an equivalent washing machine qualifies for relief.
Example, during April 2019, Fred furnished a residential property with a cooker costing £440, a washing machine costing £330, and floor coverings costing £2,200.
The cooker was sold during December 2019 for £110, and replaced with a similar model costing £460.
The washing machine was scrapped, with nil proceeds, during March 2020.
It was replaced by a washer-dryer costing £670, although the cost of a similar washing machine would have been £360.
What would the replacement furniture allowance be?
Replacement furniture relief:
Cooker (£460 – £110) = (£350)
Washing machine = (£360)
No relief is available for the initial cost of the cooker, washing machine and floor coverings.
Relief for the replacement cooker is reduced by the proceeds of £110 from the sale of the original cooker.
No relief is given for that part of the cost of the washer-dryer which represents an improvement over the original washing machine.
Illustration - Impairment losses under the accruals basis
Howard had an unfurnished property and charged rent of £800 per month payable at the end of each month.
The property was let from 06/04/2019 - 31/12/2020 when the tenant left owing 1 month’s rent which Howard was unable to recover. Allowable expenses paid in the period amounted to £500.
What is Howard’s property income assessable for 2019/20 using the accruals basis?
|Rent receivable 9 months * £800 =||£7,200|
|Impairment losses 1 month * £800 =||(£800)|
|Allowable expenses =||(£500)|
|Property income assessable =||£5,900|
Relief is available for revenue expenditure incurred before letting commenced.
This means that it must be incurred within 7 years of renting
It will be treated as though it is incurred on day 1 of renting
Hailey owned a furnished flat that she acquired on 01/06/2019.
She paid mortgage interest of £700 on the loan taken out to acquire the property.
On 01/06/2019 she incurred advertising fees of £500 and paid an insurance premium of £300 for the year to 31/05/2020.
He paid decorating costs of £900 on 15/06/2019.
The flat remained empty until 01/12/2019 when it was rented for £500 payable monthly in advance.
|Rent received (1 Dec 19 - 5 April 20)||5 months * £500 = £2,500|
|Decorating costs paid||(£900)|
|Advertising fees paid||(£500)|
|Insurance premium paid||(£300)|
Note under the cash basis the whole of the insurance premium is accounted for in the tax year because it was paid in the tax year. Under the accruals basis, when calculating the insurance premium payable, the premium has been paid for 12 months to 31/05/2020, but we only need the premium applicable until 05/04/2020, this is why 10/12 months are taken.
Note if there was furniture that was replaced for this property, then this would also be deducted when calculating the property loss.
Notefrom 2017/18 there is a restriction on the amount of mortgage interest that can be deducted from property income. In 2019/20, only 25% of the interest can be deducted from property income.
The remaining 75% is taken off the income tax liability at the basic rate of 20%.
This means that any higher rate or additional rate taxpayers will not get full relief for the interest expense.
So in this illustration, Hailey deducts £175 (25% x £700) from property income and then would deduct £105 (75% x £700 x 20%) from her income tax liability.
This is explored in more detail in Topic Property Income Finance Costs.