Types of tax

For those who want to get into the detail then here’s an ‘everything you wanted to know about tax but were too afraid to ask’ guide.

There are three types of tax that property is subject to:

Income tax

You will have to pay tax to the Inland Revenue on any income from letting out the property. You may include expenses such as fuel, insurance and maintenance costs required in letting the property to offset the rent income.

Also on offer, if you decide to live in the property you purchase (and this will have knock-on effects on issues such as council tax, student tenant rights, etc.), then under a government scheme, you do not have to pay tax on rent from a lodger in your home if the gross annual amount of rent is no higher than a specified amount. Please access the Inland Revenue website at www.inlandrevenue.gov.uk if you wish to find out what this current value is and for the latest information available. Information is also available at any post office or the university housing office.

You will only ever pay tax on your taxable profits, that is to say you have to make money before you pay tax. Income has to exceed expenditure – if you have not achieved this then you should not even be interested in this chapter. If you are in the position where income does exceed expenditure then read on.

The equation

The simple equation for calculating your income tax bill is:

taxable rental income – allowable expenditure = taxable profit

So in order for your taxable profit to be the lowest possible the taxable rental income must be minimised and the allowable expenditure must be maximised.

Minimising ‘taxable rental income’

This is very difficult to do. Taxable rental income is deemed to be any rental income earned in the period, the period usually being the tax year 6 April XX to 5 April XY ‘Earned’ means not only what the tenant has paid but also what the tenant owes even if it has not been paid yet.

Basically there are no tricks in reducing taxable rental income, apart from one – if a tenant is 14 days in arrears then you can consider that debt as a bad debt and not include this as taxable rental income. The reason you can do this is because you can file for eviction of your tenant if they fall 14 days behind. If the tenant does end up paying then you can include the income in the following accounting period.

Fourteen days’ outstanding rent is in real terms not that much and you’ll have to pay tax on the income in the following year anyway. The only real benefit is cashflow. This is because you save slightly on your tax bill and defer payment on this omitted rental income until your next tax return the following year.

Maximising ‘allowable expenditure’

This is easier to do than minimising rental income. This is because the Inland Revenue grants certain allowances based on certain definitions as well as allowable expenditure. This means expenditure and allowances can be deducted from the taxable rental income to derive the taxable profit. The two pure definitions that you need to remember for allowable expenditure and taxable allowances, as stated by the Inland Revenue, are:

1. Any costs you incur for the sole purposes of earning business profits

Any expense you incur ‘wholly, necessarily and exclusively’ for the business is fully deductible from your rental income. Any personal expenditure that you make that relates to the business is partly tax deductible from your income. To make sure you include all expenses that are allowable against your rental income, refer to the following checklist of expenses for inclusion in your tax return.

Fully tax deductible	Repairs and maintenance	All repairs and maintenance costs are fully tax deductible. Where the property has been altered so extensively that it !S deemed to have been reconstructed, the property is then considered to be modified rather than repaired, hence no amount of the expense is allowed. The only amount allowed would be the estimated cost of maintenance or repair made unnecessary by the modification. Examples of repairs and maintenance expenditure that are fully tax deductible are:painting and decorationdamp treatmentroof repairsrepairs to goods supplied with the property, e.g. washing machine.
	Finance charges	Any interest you pay on a loan that you took out to acquire a property is fully tax deductible. It is only the interest and not the capital repayment part that is tax deductible. If any of the finance raised (the loan) is used for personal use, such as a holiday, then the interest paid on the cost of the holiday is not tax deductible.
	Finance charges	The typical interest payments that are allowed are:Interest on the mortgage taken out to get the property.Interest on any secured or unsecured loans taken out to get the property.Arrangement fees charged by a lender are also tax deductible.Interest paid on the car you use to run the property business is partly tax deductible – see below.
	Legal and professional fees	Allowable expenditures are:Letting agent’s fees for the collection of rent including the VAT (unless you are VAT registered).Legal fees for evicting tenants.Accountancy fees for preparing your accounts.Disallowable expenditures are:Surveyor’s fees initially paid out to value the property (unless the survey was unsuccessful and you never acquired the property, in which case it is a fully deductible expense).Legal fees incurred due to the purchase of the property.These expenses are added to the purchase price. When it comes to calculating the capital gain when you sell the property:gain = selling price – purchase priceThis results in the purchase price being higher than the actual price paid due to the addition of initial professional fees. So the taxable gain is lower. These fees are subject to full indexation, as is the purchase price, to allow for price inflation (see capital gains section below). So you do get some tax relief but only further down the line, when you sell the property.
	Council tax, electricity, water and gas	If you are renting out a)l the rooms then all the usual running costs involved with a property are fully tax deductible. This assumes that none of the tenants make a contribution to the bills. If you let out your property inclusive of all the bills then you can fully charge all the bills you include with the rent. If you let out your property exclusive of all bills (which is the usual way) then you cannot claim. Remember, you can only claim the expense if you actually paid it!
	Insurances	Buildings insurancecontents insurancerental guarantee insuranceare fully tax deductible. Life assurance premiums are not as this is personal expenditure Car insurance is, but only partly – see below
	Advertising	Any advertising costs in connection with finding a tenant or selling your property are fully tax deductible. This includes:newspaper advertsagent’s commission.
	Ground rent	This is the rent you pay if you own a leasehold flat, typically a nominal amount of £50 per annum.
	Service charges	Service charges are incurred if you own a leasehold flat If you pay these charges then they are fully tax deductible
	Letting agent’s fees	Any fee that is charged by a letting agent is fully tax deductible, apart from any fees charged for leases created for longer than a year. If a fee is charged for creating a five-year lease then only one-fifth of the fee can be charged for each year.
	Stationery	Any stationery costs incurred in connection with running your property business are fully tax deductible. This will include items such as:all paper and envelopespostageall printing expenditure.
Partly tax deductible	Motor expenses	Motor costs are allowable but only when your car is used in connection with the property business. It is up to you to decide how much time you think you spend using your car for private use and business use. It has to be reasonable Once you have decided on the split of personal to business, say 70% personal 30% business, then you can charge the business percentage against your taxable rental income, in this case 30%. Typical motor expenses are:car insurancepetrolservicing and repairsinterest paid on the loan taken out to acquire the car.A fraction of the purchase price of the car can also be taken into account as an allowance – see below.I charge 80% of my motor expenses to the business. This is because 1 have 43 properties to maintain around the country and 1 spend 80% of my driving time on business engagements
	Telephone calls	Again this is like motor expenses. If you spend 30% of your time on the phone in connection with your business then charge 30% of:total landline call chargestotal line rental for your landlinetotal mobile call chargestotal line rental for your mobile.If there are obvious large private calls (say in excess of £5) then exclude these from the total call expense when calculating the 30% charge.If you have a fax line then charge 100% of fax expenses as it is difficult to convince the Inland Revenue that you own a fax machine for personal use!

Again this is not an exhaustive list. To make sure you legally maximise your allowable taxable expenditure you have to remember the following two principles:

• Include expenditure if it is ‘wholly, necessarily and exclusively’ needed for the business. If it is, include it. If it is not, exclude it or partly include it.
• Include a proportional amount of expenditure that is split between business and personal such as motor expenses and telephone calls.