Relief for landlords in let-out clause
Mike Goodman explains a tax concession that makes renting out your property an attractive alternative when selling is not
Sunday 07 January 1996
Reluctant landlords can take advantage of an important tax concession which came into force last April. Owners who rent out their property can claim the interest on the mortgage as an expense against rental income. Rental income is taxable, but by offsetting the mortgage interest you reduce the tax liability pound-for-pound.
You forfeit any mortgage interest tax relief (Miras) on the property but, as Miras is restricted to just 15 per cent of the interest on the first pounds 30,000 of the loan, most owners will be better off opting for the letting expenses concession.
In addition to the mortgage interest, owners can offset other costs against rental income. The main areas are marketing costs, agents' letting fees, buildings and contents insurance, maintenance, and such charges as water rates, if they are not paid by the tenants.
So if the mortgage on a flat costs pounds 400 a month and the rental income is pounds 440 net of expenses, tax is payable only on the pounds 40 per month "profit". Alternatively, were you to carry on claiming Miras, the tax relief would be pounds 30 a month at most. The bigger the rental income and mortgage, the bigger the benefit compared to sticking with Miras. For higher-rate taxpayers, the benefit is even greater, as the lower the "profit" on the rental, the lower the rental income liable to 40 per cent tax. Only interest on the original mortgage to buy the property is deductible against rental income. No further loan, for home improvements, for example will qualify. Owners who have let out their homes and opted out of Miras on their existing mortgages can still get tax relief on the mortgage on a new home.
Any losses made on lettingcannot be counted against the landlord's main income. But losses can be carried forward against any profit made on letting the following year. For example, if a tenant moves out during the tax year and there is a two-month gap in rental income at pounds 440 a month, then the total for the tax year will be only pounds 4,400. As the mortgage interest for the year totals pounds 4,800, there is a pounds 400 loss that can be carried forward.
A second home is liable for capital gains tax on sale. But the method of calculation means that few owners who let out a property which has fallen in value will be liable. The formula is based on the difference between the eventual sale price and the original purchase price, increased by inflation over the period. The gain is then apportioned between the time the owner occupied it as a principal residence and the period during which it was let.
Where there is an obvious loss, there is no indexation, but also no CGT liability. If a flat cost pounds 90,000 in 1988 and is now worth pounds 60,000, the original price is not indexed, but there is a potential pounds 30,000 loss. A loss on the sale of a property can be offset against realised profits elsewhere - on shares for example. So it might pay to realise profits on shares during the same tax year as the sale of the second home, if the loss on the property offsets gains on the shares to bring total gains for the year below the tax-free CGT allowance.
However, the CGT liability on inherited properties that are later sold is only calculated on the value of the inheritance when it passed to the beneficiary. If the beneficiary lives in the inherited property for a time, that also cuts the potential capital gains tax liability. Home-owners with negative equity who inherit a property that is free of a mortgage usually benefit in tax terms from moving to the inherited property and electing it as their main home for CGT purposes. They could then sell the former property at a loss and use the loss to offset any potential CGT liability on selling other parts of the inheritance, such as shares.
Home-owners who bought a council property under their right to buy will not be penalised if they later let the property. But if they sell within three years of purchase, they will forfeit the discount. And when calculating CGT, the original discounted purchase price is used as the base.
Whereas there are tax concessions for mortgage holders who let their homes, there could be complications with lenders. Lenders worry about tenants claiming long-term occupation rights should they have to repossess. But as current legislation allows for what are called shorthold or fixed- term tenancies, this should not be a problem. Normally lenders will increase the mortgage rate by 0. 5 per cent to 1 per cent if a property is let. But many waive this levy if the property is let temporarily to a family, a responsible couple or individual.
o The Inland Revenue and the Department of the Environment publish leaflets on the tax implications of letting a property. Local tax offices can advise.
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