Income Tax on Rental Property

Navigating income tax on rental property earnings is crucial for anyone letting residential property in the UK. Whether buying to let, managing ongoing rental income, or considering selling a rented property, understanding how tax implications affect your profits is vital for wise property investment.

The Conservative budget, previously introduced by MP George Osborne, signalled a significant shift for the buy-to-let sector. These changes were designed partly to cool the overheated property markets in London and the South East, particularly targeting residential landlords by limiting potential tax relief and increasing costs.

At The Property Buyers, we help landlords navigate these changes with tailored solutions, allowing you to make informed decisions and optimise your returns. Our UK-wide service is designed to simplify your property journey from start to finish.

Who is Affected by the Tax Changes?

If you fall into any of the following categories, these changes apply to you:

• UK residents owning residential rental properties either in the UK or overseas
• Non-UK residents owning UK residential property
• Individuals in partnerships letting residential property
• Trustees or beneficiaries liable for income tax on property profits

However, you are exempt if you are:

• A UK resident company
• A non-UK resident company
• Letting furnished holiday accommodation

1. Stamp Duty Increase on Additional Properties

Since April 2016, purchasing a second property has attracted an additional 3% stamp duty surcharge. For example, if you’re acquiring a property worth over £400,000, you’re looking at a stamp duty cost of approximately £22,000 — payable before you’ve earned any income.

This upfront cost can significantly impact your yield and should be a key factor when considering buy-to-let as an investment strategy.

2. Restrictions on Mortgage Interest Relief

Previously, landlords could subtract the full cost of mortgage interest from their rental income. Now, this relief is limited to the introductory income tax rate (currently 20%).

This means:

• Basic-rate taxpayers are unaffected
• Higher-rate taxpayers (40%) and additional-rate taxpayers (45%) will see increased tax bills

This change can drastically reduce profit margins, especially for landlords with high loan-to-value properties.

3. Income Tax Charged on Rental Revenue, Not Net Income

A subtle but significant change is that income tax is now calculated based on total rental revenue, not profit after mortgage interest. While capital gains tax on buy-to-let property remains between 18% and 28%, capital investments in other financial instruments may be taxed as low as 10%.

This puts traditional property investments at a disadvantage compared to other investment forms.

4. Abolishment of the Wear and Tear Allowance

Previously, landlords of furnished properties could claim a flat 10% wear and tear allowance. This has been replaced with a system requiring proof of actual costs.

You can now only claim relief for replacing furniture, appliances, and kitchenware — and only if you retain documentation like receipts or invoices. Although this change promotes accurate deduction, it increases administrative overhead.

Overall Impact on Buy-to-Let Investors

These combined reforms have led many investors to see decreased annual returns. Increased taxes, fewer deductions, and higher upfront costs make buy-to-let investments less appealing than before.

As a result, many landlords are exploring alternative strategies, such as holding property within a limited company structure to maintain profitability.

Using a Limited Company to Offset Tax Impact

One way landlords are adapting is by purchasing rental properties through limited companies. Here’s why this route is proving attractive:

• Mortgage interest is considered a business expense and is fully deductible
• Corporation Tax is lower — currently at 20%, decreasing to 17%

Withdrawing Money from a Limited Company

There are three primary methods:

1. Salary and Benefits:

• Register as an employer with HMRC
• Pay income tax and National Insurance contributions
• Declare personal use of company assets as benefits and report accordingly

2. Dividends:

• First, £5,000 in dividend income is tax-free
• Further dividends are taxed at:
  • 7.5% (basic-rate taxpayers)
  • 32.5% (higher-rate)
  • 38.1% (additional rate)

3. Directors’ Loans:

• Can withdraw funds as a loan, provided it is repaid within the financial year
• Must maintain accurate loan records for tax reporting

Note: Limited companies are not eligible for the annual capital gains tax allowance (£11,100), which may impact profit upon sale.

Projected Financial Effects of New Tax Rules

These regulations will likely push many landlords into the higher 40% tax bracket.

Example Scenario:

• Rental income: £10,000
• Mortgage interest: £8,000
• Tax liability to HMRC: £3,200
• Net loss: £1,200 per year (excluding maintenance)

This scenario illustrates how buy-to-let properties may result in losses rather than profits under the current tax regime.

However, personal residences remain attractive assets due to their exemption from capital gains tax upon sale. Many homeowners leverage this by refurbishing, withdrawing funds, and upgrading over time.

Conclusion

Understanding income tax on rental property is essential for maximising returns and avoiding unexpected liabilities. The new rules challenge traditional buy-to-let models but offer alternative structures — such as incorporation — to sustain profitability.

Whether you’re a seasoned landlord or a new investor, expert advice and a solid tax strategy can help you maintain a successful property portfolio.

To discover how to reduce your income tax burden on rental property and explore the best options available, contact us at The Property Buyers or call Baggy on 07971 241120.

We specialise in offering flexible, transparent, and compliant solutions to property owners and landlords across the UK. Let us guide you through every step of your property journey with confidence.