Mimimising Tax on Rental Income

DickyBoy_2

Dear All

I have read with interest some of the posts on this subject and was hoping that I might be able to get some advice on my own situation.

Due to my girlfriend changing jobs, we have to move out of my flat and rent somewhere that makes her journey to work easier. I am therefore renting my own flat out and wanted some advice on what I can do to mimimise my tax liability on this income, which I understand will be taxed at my marginal tax rate.

I think I am correct in saying that I can offset my mortgage interest, running costs (e.g. service charge/ground rent/agent fees) and 10% wear and tear allowance vs the income, but thats about it. I currently have a repayment mortgage - stupid question, but if I change this to interest only, is my whole mortgage payment deductable? Is there any practical disadvantage of doing this?

One idea that has been suggested to me is that I actually utilise my parents as Landlords (somewhere else on this forum it was suggested that it is the designated Landlord who was liable to tax, irrespective of ownership of the property - this doesn't sound right, but no one corrected the post that I read it in) - they are pensioners and what little tax they pay is at a lower marginal rate than myself, so they receive the rent and then gift it back to me (over 2 years if necessary), taking advantage of the annual exempt amount. Does that stack up, or is the part about them being Landlords and therefore liable incorrect?

I will probably sell the property in a year or so, so we are talking about total income from the property of around £11,000.

Just to be clear, I'm not looking to evade paying tax, but obviously am keen to pay as little as is legitimately/legally possible!

Something else to throw into the pot - I am employed (PAYE) 4 days a week, but I am trying to set up my own business to run in my spare time. In order to do this I am working from home using our second bedroom as an office - can I offset any of the rent as a business expense?

Many thanks in advance for your help.

Kind regards
D

MarkyMarkD

The bit about designated landlords was incorrect. If it's your property, YOU are liable for tax on the rental income.

Changing to interest only will mean that 100% of your mortgage payments are tax-deductible. But that element will be virtually the same (in the short term) as the element of a repayment mortgage which relates to interest. So it's only worth changing repayment method if you have another reason for doing so (like because you need to reduce your cash outgoings), or expect to be letting it for a long time IMHO.

dunstonh

You couldn begin to investigate buying the property in your pension (from april 2006). The rental income would then be tax free along with any growth in the property value. Therefore avoiding any capital gains tax.

However, the downsides to that are that when the inevitable house price decline happens and the next cycle of higher interest rates occurs, you wont be able to access the capital from the sale to get yourself out of trouble.

Property in pension is really only designed for those that can afford buy to let over the long term and not those who have taken the risky option of mortgaging themselves up to buy a second property.

Rafter

Not sure where your tax accountant friend is coming from. You can deduct mortgage interest from the rental income whether you are employed, self-employed etc - it is just a calculation to work out your total taxable income.

You also have 3 years exemption from any capital gains implications as a result of renting out what was up to now your principle residence.

Certainly worth ensuring some of the rental cost on your new property is deducted from your self-employed income including a percentage of bills, council tax etc. You can normally make an estimate of say 1/5 of total bills if there are five usable 'living' rooms in the new place.

The cost of switching to a buy to let mortage may not be worth it either.

Good luck.

R.

MarkyMarkD

Agreed with Rafter.

Interest incurred on any loan obtained in order to purchase the property is allowable as a deduction. It doesn't matter what sort of loan that is.

A BTL mortgage will almost definitely cost more than a residential mortgage. As long as your lender is happy with you letting, then stick to your residential mortgage whilst you are able to do so.

Plumpud_3

The bit about designated landlords was incorrect.  If it's your property, YOU are liable for tax on the rental income.

No you are wrong. I posted the original post, and as a recently ex-Inland Revenue employee dealing with letting income, I can assure you I am correct.

It is logical if you think about it. If you rented a property, then sub-let a room, who would be liable for declaring the rent from the sub-let room? You would, as the landlord, not the owner.

The first stop when considering renting out a property, should be obtaining a copy of IR150 Taxation of Rents

http://www.inlandrevenue.gov.uk/pdfs/ir150.pdf

this explains nearly everything regarding rental income and taxation. It is what the Tax Office refer to in the first instance.

With regard to making your parents the Landlords, then them gifting the money back to you, would most likely be viewed as tax avoidance. Whilst each action is allowable under legislation, the fact that they have been done in order to avoid paying tax would most likely make them disallowable. The Inland Revenue would most likely view your parents as agents and you as the landlord.

I would strongly suggest you contact your own Tax Office to get something agreed in writing. Pleading ignorance is no defence, and will not lessen the interest and penalties due, should the Inland Revenue not agree with your interpretation of the rules at a later date.

MarkyMarkD

No you are wrong.  I posted the original post, and as a recently ex-Inland Revenue employee dealing with letting income, I can assure you I am correct.

It is logical if you think about it.  If you rented a property, then sub-let a room, who would be liable for declaring the rent from the sub-let room?  You would, as the landlord, not the owner.

I think you are still missing the point.

If you own a property, only YOU can be taxed on the income for letting it out.

You cannot arbitrarily decide that your senile granny who has no taxable income is the landlord, so that you avoid tax.

The original poster owned his property.  He was asking if he could nominate his parents as landlords.  HE CANNOT.

Your scenario is completely different.  If you rent a property and sub-let it (or part of it) to someone else, OF COURSE it's you who is the landlord.  You are sub-letting part of the property which is legally let to you.  That's why it's YOU who is taxed on the income.  Once again, you couldn't nominate your granny as the landlord or some other irrelevant party who happens not to pay tax.

Can you please read the original post fully and then explain where I am wrong and how your scenario is relevant?

----


Having read the second part of your post, having told me that I'm wrong, you then admit that he IS the landlord and his parents, despite being named as landlords, are actually merely agents for him.

Err ... that's what I was saying.

Plumpud_3

What I said is correct. The scenario on this thread falls down, in that he suggested the parents gifted the money back to him. Whilst they can make tax free gifts to whom they like, the fact that the money came from the rental income of his property would indicate tax avoidance, and would most likely be viewed as such by the Inland Revenue.

Of course the Inland Revenue would have to pick this up. In the normal course of completing the self assessment tax returns, and even an enquiry into the income from property aspect would probably not pick this up. Only if a full enquiry was undertaken would this be picked up, where full details of income and expenditure have to be shown. But should this be detected, the penalties would be high (plus interest and possible surcharges).

As another example, it is quite common in University towns, for wealthy parents to buy a large property (with or without a mortgage) and allow their child to live there. The child then lets the rest of the rooms as the landlord. They keep the money as their income, and declare it as such. If they pass the money to their parents, then they are liable for the tax. The tax aspect only comes into play when the property is sold, with capital gains tax.

MarkyMarkD

Plumpud, your understanding of taxation really does concern me as someone who claims to have worked for the Inland Revenue.

You refer to IR150. But IR150 states that a person carries on a rental business if:

(a) they own or have an interest in land or property in the UK; and
(b) they enter into transactions which produce rents or other receipts ...

It is not legally valid for someone who doesn't own property to rent it out to someone else. If they purport to do so, they can only do so as agent of the actual owner.

And hence, the OWNER is the one who is carrying on a rental business and is subject to tax.

All the literature suggesting that parents assist their children to buy property states that they should guarantee loans in their child's name, and that the child should let out the rooms and benefit from "rent a room" allowances and their own tax allowances.

They don't suggest that the parent buys the house and then PRETENDS that the child is the landlord - because that is nonsense.

If your tax office happened to take the dubious view that this was OK, that's up to you. But it doesn't make it right. And it doesn't make it sound advice for anyone to give to someone potentially/actually in this situation.

moneyandmountains

From what has been posted above and from filling in self-assessment I understand that mortgage interest is deducted from rental income before tax assessment.

Is there any benefit of increasing the mortgage amount (i.e. releasing capital) from a mortgage on an existing property? For example, if the current property value is greater than the mortgage amount.
I realise that normally the fact that most savings rates are smaller than borrowing rates mean that it is better to pay of the mortgage debt.

For example, if a 40% tax payer owns a property with a mortgage interest of 6%, then the effective rate paid on that mortgage is 60%*6% = 3.6% (as the rest would go to the tax man anyhow). Now all remains it to try and beat 3.6% per annum, which is not that infeasible. Obviously, the benefits are not as significant for a basic rate tax payer.