Letting residential property is treated as running a business whether there is one property involved or one hundred. This means that tax is payable on the ‘net profit’ – rental income less expenses incurred in the rental business and certain allowances (explained in a moment).

Landlords who run their letting business via a limited company have to pay corporation tax, for which different rules apply. Those who retain personal ownership of their properties must pay income tax.

In arriving at their taxable rental income, landlords are permitted to deduct some special allowances to arrive at their income tax liability. For example, when letting a furnished room within his or her own home, the Rent a Room scheme allows the landlord to receive gross income – including any charge for meals, laundry or other services – of £4,250 tax free (correct as at June 2009 – see www.direct.gov.uk).

Landlords who choose not to use the Rent a Room scheme can claim the expenses of letting, including a proportion of mortgage interest, against rental income in the normal way.

Another special landlord allowance (not available to landlords taking advantage of the Rent a Room scheme) is the Landlords Energy Saving Allowance (LESA). This permits landlords to claim up to £1,500 for each rented property as an offset against their taxable income for the installation of energy saving improvements, including loft, cavity wall and floor insulation, upgraded heating systems and draft proofing.

In the case of fully furnished property, which the Inland Revenue says is property “capable of normal occupation without the tenant having to provide their own beds, chairs, tables, sofas and other furnishings, cooker, etc’,”(see Furnished residential property: wear and tear allowance, available from www.hmrc.gov.uk)  ,there is a wear and tear allowance available to the landlord equivalent to 10% of the ‘net rent’ from the furnished letting. Landlords have the option to disregard this allowance and instead set against rental income the cost of replacing contents (but not of their initial purchase) when renewal becomes necessary.

If a landlord with both furnished and unfurnished property claims the wear and tear allowance, this must be calculated on the basis of the net rent from furnished properties only. The net rent is defined as rent less any charges paid by the landlord that would normally be borne by a tenant (for example, council tax, or water and sewerage rates).
The wear and tear allowance is intended to cover appliances and furnishings, not fixtures such as baths, wash basins, toilets and central heating systems. This means that whether or not the wear and tear allowance is claimed, the net cost (cost less the proceeds of the sale of the fixtures being replaced) of replacing such fixtures can usually be claimed against rental income.

When completing tax returns, the expenses that landlords can deduct from their letting income to arrive at a net taxable amount include the following (provided they have been incurred solely for the purposes of running the letting business:

• interest (but not capital repayments) on loans and mortgages used for the letting business
• bank charges on an account used for the business
• buildings and contents insurance
• utility bills paid by the landlord
• council tax on rental property paid by the landlord
• the cost of maintenance and repairs (but not improvements), including replacement of appliances and furnishings (but not if the 10% wear and tear allowance is claimed), and of fixtures
• services such as cleaning and gardening
• advertising costs
• the cost of Gas Safety and other certificates and licences
• training courses and subscriptions to relevant magazines
• other direct costs of the letting business such as phone calls, stationery, travelling, loss of rent insurance cover, the cost of credit checks, debt recovery and associated legal costs
• any rent, ground rent, or service charges paid by the landlord
• any letting agent’s fees
• legal fees for lets of a year or less, or for renewing a lease for less than 50 years
• accountant’s fees.

Costs incurred prior to receiving any rents (up to seven years before) can be claimed, provided they are for the purposes of the letting business and are not ‘capital’ in nature (costs of acquiring and improving the property) and are such that they would be allowable had rent already been received. So, repairs to a property would be allowable, but the cost of improvements (often a fine line) would not (although the cost of improvements are deductible from any capital gain when the property is sold).

When an existing property is first introduced into a letting business, the tax rules allow the property to be refinanced and tax relief to be obtained even if the proceeds of the loan are not used for the letting business. Interest on loans used to finance the letting business, including the purchase of property, are allowable even if secured against property which is not part of the business.

Landlords whose usual place of abode is outside the UK still have to pay tax on their UK letting income. Under the Non-Resident Landlords (NRL) Scheme (www.hmrc.gov.uk), tax at the standard rate must be deducted and accounted for either by the non-resident landlord’s UK letting agent or by his or her tenants (tenants who make payments of less than £100 per week to non-resident landlords do not have to deduct and account for tax unless they have been told to do so by the Revenue’s Charities Assets and Residency office (CAR), but there is no similar concession for letting agents).

Non-resident landlords whose UK tax affairs are up to date, or have had no UK tax obligations before, or do not expect to be liable to UK income tax, or are not liable to pay UK tax because they are Sovereign Immunes (these are generally foreign heads of state, governments or government departments), can apply to receive their rent with no tax deducted.

If HMRC grants the application it will send a notice of approval to the non-resident landlord, and a separate notice to the letting agent or tenants named in the application form, authorising payment of rent to the non-resident landlord without deducting tax. Authority to pay rent to a non-resident landlord with no tax deducted is generally backdated to the beginning of the quarter in which HMRC receives the application.

Further guidance and relevant forms are available from www.hmrc.gov.uk.
Whether or not their entire income comes from rental income, and whether or not they are also employed full or part-time, landlords with rental income and/or allowable expenses should complete an annual tax return declaring their income (even if HMRC does not request a return, landlords have a legal responsibility to declare their income if this gives rise to tax liabilities).

If the business is run as a partnership, say between a husband and wife, each partner should make an annual tax return, each declaring their share of both income and expenses. Businesses run as limited companies will be required to complete an annual corporation tax return.

There are different types of personal tax return containing different supplementary pages, which have to be completed depending on circumstances. If total income from letting (before deduction of expenses) is less than £15,000, only a shorter return may be required in which only the total of expenses need be included; if it is £15,000 or above, a longer return including pages specific to letting income will be required, including a breakdown of expenses. HMRC has an explanation of the process on www.hmrc.gov.uk.

Returns should be completed even where the letting business is making losses, since these can be carried forward and set against future profits.

Landlords who have unused personal tax allowances can set these against their taxable income from letting.

Be aware that there are also deadlines for submitting tax returns, and penalties and interest charges on late submissions.

Landlords must pay capital gains tax on the profits they make when selling off their investment properties (tax is payable on the net sales proceeds after legal and other selling costs, less the costs of buying the property in the first place, and less the cost of any  improvements ).

As from 23 June 2010, standard rate taxpayers pay 18% on their capital gains realised after that date but higher rate taxpayers pay 28%.

There is (for 2010-2011) an annual tax exempt amount of £10,100 to deduct. Once this is taken off, any remaining amount of gain is taxed at 18 per cent or 28 per cent,

However, since capital gains are added to income to determine whether or not the higher rate of income tax applies (for the tax year 2010/2011 it kicks in when taxable income less personal allowance exceeds £37,400), only standard rate taxpayers with relatively small capital gains are likely to be eligible for the 18% rate. Most landlords will find they have to pay 28% on the gains made on their properties.

However, there are concessions for landlords whose rental property has previously been their principal private residence. In such circumstances gains arising in the first three years after moving out are not taxable (they are considered an extension of the period in which the property was occupied as the landlord’s principal private residence – and most capital gains on the sale of private residences are exempt from CGT).

If a property that was formerly a principal private residence is sold after having been let out for more than three years, any capital gains must be apportioned between the period of use as a private residence (plus three years) and the total time owned. Only the first is exempt from CGT.

Anybody owning more than one property can, within two years of each purchase of an additional property, write to HMRC to nominate one as his or her principal residence. If no nomination is made, the matter will be decided by HMRC on the evidence available, such as where mail is usually directed, and the address used for your entry on the Electoral Role.  Married and civil partnership couples have to agree on the nomination they make (by both signing the HMRC notification) and, unless formally separated, may between them have only one principal private residence at a time. Unmarried couples may each own a home that qualifies as their principal residence.

Landlords moving out of their principal residence in order to let it out may also claim ‘private letting relief’. Up to £40,000 may be claimed, and as with the annual capital gains exemption , both a husband and wife or civil partners who are also partners in the property and the letting, may each claim this amount.

The Inland Revenue has a page on its website devoted to: ‘How to calculate capital gains on property’ – www.hmrc.gov.uk