Earning rental income is one of the common ways that taxpayers in the UK make additional income.
However, this income from rental properties is a taxable income in the UK.
The tax rate applies varies, it could either be 20%,40%, or 45%.
The reason for the application of different tax rates is because when computing the tax due, the total income of the individual earned in the tax year is put into consideration.
So that is why landlords always want to ensure they claim all the expenses due so as to reduce their additional income taxable.
In this blog post, I will like to explain some of the ways to avoid making the mistake of paying too much tax on your rental income.
How the tax is calculated on rental income.
To determine the tax due, the rental income will need to be computed. To compute the rental income, the actual rent receiveable will be deducted from the expenses associated with running the rental property.
The net rental income is taxable though the taxable rental income may be the same for two taxpayers. The tax paid is determined by their total income earned throughout the year and the personal allowance available to them.
How does the basic taxpayer pay tax on rental income?
The basic taxpayers are individuals that pay tax at 20%, the reason for this is that their total income earned is between £12,571- £50,270 in the tax year 2022/23. Therefore if the only earned income in the tax year is the rental profit of less than £12,570, the tax due will be 0% because of the enjoyment of personal allowance.
Some other taxpayers that earn more than this stated amount could still pay tax at 20% if they have their personal allowance increased because of tax benefits or tax reliefs that they currently enjoy.
In the year 2022/23, every taxpayer is allowed to enjoy a £12,570 personal allowance, personal allowance is the tax-free element of our taxable income.
The personal allowance (12,570) can be increased or decreased based on individual tax personal situations.
These taxpayers that are basic taxpayers, pay tax on their rental income at 20%.
Another tax relief they enjoy is the ability to be able to enjoy relief for finance costs at 20% which is invariable means that they enjoy tax relief on their finance cost.
How Higher rate/Additional taxpayers pay tax on their rental income
The higher taxpayers pay tax on their rental income at 40%, individuals that earn within £50,271 to £150,000 are referred to as higher rate taxpayers.
The tax rate paid on rental income earned by these landlords is 40%.
For the additional taxpayers, they are those taxpayers that earn income over £150,000.
Their taxable rate is 45% of their net income.
Unlike the basic taxpayers, they only enjoy tax relief on their finances at 20% rather than 45%.
This simply means that landlords within these bands are actually affected negatively in two ways.
First by paying tax on their rental income at 40% /45% and also being given 20% as relief on their finance cost.
This actually makes many taxpayers think if there are other ways of reducing the tax burn to the minimum level.
Different methods of reducing the tax paid by higher and additional taxpayers.
There are several ways of planning the tax paid by higher and additional taxpayers in the UK.
However, they have their tax consequences and you should be careful to ensure that these are done carefully.
The main and common consequences are usually the capital gain tax and stamp duties.
Some of these methods are explained below
Gifting the equity or debt to the husband/wife /partner:
The higher-earning partner could gift the equity of the property to the other, thereby sharing the tax burden and the partner would pay tax on the rental income at 20%.
Setting up a special vehicle company: When this method a special vehicle company is set up, the rental income will be taxed under corporation tax at 19% rather than 40% /45% under income tax if the taxpayer is higher /addition taxpayer.
Absolute care must be taken when planning the strategies to reduce the tax paid on rental income.
The reason is that all these methods explained above all have different tax consequences.
If you would like to read more about rental income in the UK
If you would like us to support you with your rental accounts or tax advisory issues, kindly contact us.