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1 Minute Guide to Owning a Second Property

Introduction
Many taxpayers own a second property, i.e. in addition to their own home. This property may have been inherited, or it may have been bought as an investment (e.g. to generate rental income, such as ‘buy to let’). This 1 minute guide deals with residential property which is let out and subsequently sold by UK resident taxpayers.

10 Key Points…

How is income from a second property taxed?
The income from a second (and additional) let property is taxable as a ‘Schedule A business’. This broadly means that receipts and expenses from all UK properties are aggregated to produce a profit or loss. The profits taxed are normally those of the tax year itself (i.e. 6 April to the following 5 April), and is dealt with under self-assessment. Special rules apply to the UK rental income of non-UK residents.

How is rental income calculated?
Rental profits are calculated in broadly the same way as business profits. Expenses must be ‘revenue’ in nature (e.g. accountancy fees, repairs etc), as opposed to ‘capital’ (e.g. the cost of the building, surveyors fees and legal fees), and must be ‘wholly and exclusively’ incurred for business purposes. Capital allowances for certain fixed assets are deducted as a business expense.

How are rental losses treated?
Rental losses can be carried forward and set off against future rental profits, or can be set off against total income of the same or next following year if they relate to capital allowances or allowable agricultural expenditure.

What tax relief can be claimed for furniture and fittings?
Capital allowances cannot be claimed for expenditure on furniture, fixtures and fittings in let residential property. However, a ‘wear and tear’ allowance may be claimed instead. The calculation of this allowance is 10% of net rents (i.e. rents less payments that would normally be borne by the tenant, such as water rates). An alternative allowances to the wear and tear claim is the ‘renewals basis’. Under this method, no relief is given for the original cost of furniture, fixtures etc, but a deduction may be claimed for the cost of replacing the asset.

Can tax relief be claimed for interest paid on property loans?
Yes, tax relief can be claimed in respect of interest paid on a loan to buy property which is let. The loan interest is claimed as a deduction from rental income. Some taxpayers extend their mortgages to buy a second property. However, it can sometimes be difficult to distinguish between the loan interest paid on your mortgage and the interest paid on your let property. Separate loans (or alternatively separate loan interest certificates from your lender) should make life more straightforward!

What about tax relief for the cost of the let property?
The cost of the house is capital (i.e. liable to capital gains tax, not income tax), as is the cost of any additions or improvements (e.g. an extension or a new patio). However, if damaged parts of capital items (e.g. kitchen cupboards) are replaced with the nearest modern equivalent of a similar standard, a deduction may usually be claimed. But if they are replaced with expensive, customised and higher quality versions, HM Revenue & Customs may regard this as capital expenditure and income tax relief could be denied. However, the taxman does accept that replacing single glazed windows with double glazed equivalents count as expenditure on repairs.

What happens when the let property is sold?
When you sell let residential property (which has never been your main residence), any gains (i.e. increase in value between buying and selling the property) is normally liable to capital gains tax. This tax is charged on total gains in tax year, less:
Capital losses (of the same year, a previous year or carried back on death);
Taper relief (if this is available) at the non-business asset rate (unless the property is a ‘furnished holiday letting’ – see below); and

The annual capital gains tax exemption.
There are also certain shelters from capital gains tax (such as ‘Enterprise Investment Scheme’ or ‘Venture Capital Trust’ investments) that could be considered. In some cases, a gain on the disposal of land can be liable to income tax, not capital gains tax, under certain tax avoidance legislation ‘to prevent the avoidance of tax by persons concerned with land or the development of land’. Professional advice in this area is strongly recommended.

Can anything be done to save tax?
Quite possibly! For example, married couples may wish to consider owning and renting the let property jointly. This would enable the rental business profits to be divided equally between them (so that two sets of personal allowances and basic rate tax bands are potentially available to reduce the overall income tax liability). When the property is sold, both spouses may also be able to deduct the annual capital gains tax exemption from any gain on disposal, to the extent that those exemptions have not been used elsewhere.

What if the second let property is a holiday home?
Special tax treatment applies to ‘furnished holiday lettings’. For example, any loss arising can be set off against other (non-rental) income; profits are treated as earned income for pension purposes; and furnished holiday lettings are generally treated as a trade for the purposes of claiming various types of capital gains tax relief, such as taper relief. However, certain conditions must be satisfied for furnished holiday lettings treatment to apply, and professional advice in this area is once again recommended.

How are property leases treated for tax?
The grant or assignment of a lease on the property for more than 50 years is treated as a disposal for capital gains tax purposes. If the lease is for 50 years or less, part of the least premium is treated as additional rental income which is taxable in the year the lease is granted (i.e. the amount of the premium less 2% for each complete year of the lease, except the first). The rest is subject to be capital gains tax rules.