Tax on rental income

oldestgnome

Thanks to G_M for the great stickies & guides.

I've read and researched and want to check that my understanding is correct. I understand there are SDLT and CGT impacts as well but want to focus on the below.

There are two possible scenarios.

1) Rent out a property owned outright via an agent. The owner is a basic rate tax payer PAYE annual income 20k. Rental income will be circa £10k a year with allowable expenses (agent fees, accountant fees, insurance, basic repairs etc) leaving a profit of 5k a year.

This means an income of 25k from both sources and 20% tax paid on the rental profit via a self assessment tax return.

2). Rent out a property owned with a mortgage of 100k with an interest rate of 3%. The owner is a basic rate tax payer PAYE annual income £20k with sufficient equity to get the mortgage. Rental income would be circa 10k a year with allowable expenses as above of 5k a year not factoring mortgage payments in.

This means an income of 25k from both sources and 20% paid on the rental income via a self assessment tax return in addition to the below mortgage tax reliefs as well?

Tax year 19-20 would result in a 25% mortgage tax relief on mortgage interest of approx £750
Tax year 20-21 would need to retrospectively claim 20% tax credit back on mortgage interest of £600.


Is the above 2 scenarios the correct understanding of tax implications?
Does it make any sense to go for option 2 over option 1?

Thank you in advance for your input.

wesleyad

If I'm reading it correctly you have missed out a crucial part.

In scenario one you have invested the total amount, in scenario 2 you have 100k mortgage, therefore that 100k from 1 still exists. That can then be invested elsewhere, earn interest, other BTL properties etc.

00ec25

if you are going to pay an accountant then leave the maths to them

as a basic rate taxpayer with the size of figures you are talking about there is no danger you will hit higher rate so the interest restriction has zero impact on you. Paye gross 20k means 8,150 taxable + 5,000 rental profit = 13,150 total taxable income. Higher rate tax starts at 34,500 so you are barely 38% of the way towards being a higher rate taxpayer.

scenario 1 rental profit 5,000
tax 20% = 1,000

scenario 2
rental profit 5,000 less interest £750 = 4,250
tax on profit = 850
less tax credit £2250 (75%) @ 20% = 450
net tax payable 850 - 450 = 400

in 20/21 100% of the 3,000 interest gets 20% tax credit.
so profit 5,000
tax on profit = 1,000
less tax credit 3,000 = 600
net tax payable 1,000 - 600 = 400

as a basic rate taxpayer there is zero impact provided your rental profit does not push you into a higher tax band. On those figures it won't

for more complex scenarios, read the examples:
https://www.gov.uk/guidance/changes-to-tax-relief-for-residential-landlords-how-its-worked-out-including-case-studies

saajan_12

oldestgnome wrote: »

Thanks to G_M for the great stickies & guides.

I've read and researched and want to check that my understanding is correct. I understand there are SDLT and CGT impacts as well but want to focus on the below.

There are two possible scenarios.

1) Rent out a property owned outright via an agent. - so you have the capital in your account? The owner is a basic rate tax payer PAYE annual income 20k. Rental income will be circa £10k a year with allowable expenses (agent fees, accountant fees, insurance, basic repairs etc) leaving a profit of 5k a year. 50% of income is a lot to spend on non financing expenses. Is the property particularly run down / do you expect particularly poor quality tenants who stay for short stints only?

This means an income of 25k from both sources and 20% tax paid on the rental profit via a self assessment tax return.

2). Rent out a property owned with a mortgage of 100k with an interest rate of 3%. The owner is a basic rate tax payer PAYE annual income £20k with sufficient equity to get the mortgage. Rental income would be circa 10k a year with allowable expenses as above of 5k a year not factoring mortgage payments in.

This means an income of 25k from both sources and 20% paid on the rental income via a self assessment tax return in addition to the below mortgage tax reliefs as well?

Tax year 19-20 would result in a 25% mortgage tax relief on mortgage interest of approx £750 - no, you only paid 20% tax on the income as a basic rate payer, so you only get 20% relief.
Tax year 20-21 would need to retrospectively claim 20% tax credit back on mortgage interest of £600.


Is the above 2 scenarios the correct understanding of tax implications? - No, the staggered mortgage relief doesn't apply to basic rate tax payers.
Does it make any sense to go for option 2 over option 1? - yes, if you don't have the £100k capital to invest in the property, or want to invest elsewhere eg in Stocks&Shares.

Thank you in advance for your input.

The staggered tax relief on mortgage interest only applies to higher rate tax payers. You only get relief upto the same % as the tax you paid on the rent, ie 20% assuming your personal allowance is used up by your other salary.

Whether to borrow the capital or buy outright surely depends on the funds you have available, not on the tax. While you get mortgage relief on the interest, you still have to pay the interest in the first place, ie pay £3000 per year, get £600 relief, so net pay £2400. This is a definite amount you HAVE to pay if you have a mortgage. Assuming you have £100k capital, can you still take the mortgage and invest your £100k elsewhere and make a better return than 2.4% guaranteed?

00ec25

saajan_12 wrote: »

The staggered tax relief on mortgage interest only applies to higher rate tax payers.

that is technically incorrect - there are scenarios where a basic rate taxpayer will not get all of their interest eligible for a tax credit