Rental Properties: Tax Issues

The past few decades have seen a substantial increase in the number of property owners who let one or more houses to tenants, driven in part by relaxations in lending, rising property prices and some tax advantages.

At the time of writing (i.e., before the autumn budget on 30 October 2024), the question is whether rumoured tax changes, such as an increase in capital gains tax (CGT), will have a substantial impact on the popularity of such investments, with many reports of owners divesting themselves of such assets.

In the meantime, and pending any future changes, this article looks at the income tax, CGT and inheritance tax (IHT) aspects of let domestic property.

Income Tax

For most people, properties that are not their own main residence will be held to produce income in the form of rent. This is subject to income tax at the owner’s marginal tax rate, but there should be no charge to National Insurance contributions.

A deduction from the rent can be claimed for revenue expenses such as agent’s fees, repairs, some travel expenses and the like. Alternatively, the gross rent can be reduced by a property allowance of £1,000 and no expenses can be claimed. Joint property owners will each have a property allowance, but this cannot be claimed if a deduction is made for mortgage interest, and it does not apply to property businesses carried on in partnership or where rent-a-room relief applies.

A deduction can be claimed for mortgage interest, but instead of reducing the gross rent, this is claimed in terms of a tax deduction calculated at 20% – so higher or additional rate taxpayers receive the same level of relief as basic-rate taxpayers. Note that those renting out furnished holiday letting properties could claim the full amount of mortgage interest as a deduction from income. However, the tax rules for furnished holiday lettings are to be abolished from April 2025, and the normal mortgage interest rules will then apply.

The initial cost of domestic items such as cookers, fridges and furniture is not deductible, but the cost of replacement with a similar item can be claimed. The capital cost of, for example, new or replacement central heating, gas and electricity systems is not allowable against income.

Capital Gains Tax

Gains on the sale or disposal of let property are subject to CGT at the residential property rates of 18% or 24%. As usual, the associated costs of acquisition and disposal can be deducted, as can the cost of any capital improvements made to the property that are still in existence on sale or disposal.

If the property had been used at some point as the owner’s only or main residence, the gain can be apportioned on a time basis with the proportion relating to the period of occupation, the last nine months of ownership and some other periods being exempt.

Inheritance Tax

Let property will form part of a taxpayer’s estate on their death and there are no specific IHT exemptions. Despite the landlord spending time on managing the property or a portfolio of buy-to-let properties, this will be classed as an investment business, so business property relief for trading ventures will not apply. As for other property, if a rental property is left to a spouse or civil partner this will generally be exempt from IHT. However, liability will potentially arise on a future transfer to the next generation. Such a liability on death could be avoided if the property is transferred and the transferor survives for seven years. However, such a lifetime disposal would be subject to CGT.

Practical Tip

If rental income from the UK or abroad for previous years has not been declared to HMRC, a voluntary disclosure can be made under the ‘let property campaign’. Generally, a voluntary disclosure will be subject to a lower penalty than one initiated by HMRC. However, professional advice is recommended in such cases.