Rental Tax Rules

Budget News

Gordon Brown made a spectacular U turn on the plan to include residential property in SIPPs. The proposed tax relief has also disappeared for other "tangible moveable property" such as classic cars, fine wines and works of art.

However the government is making it clear that it wants to encourage investments in property but through collective investment schemes, such as real estate investment trusts (Reits).

Reits have proved very popular in the US, Australia, Singapore and Japan. They have the dual purpose of boosting institutional investment in private rented housing and opening up investment in residential and commercial property to ordinary people; doing for property what unit and investment trusts do for shares.

Reits would pay no corporation tax on income or capital gains within the trust. They would distribute at least 95 per cent of their rental income and some of their capital gains to individuals who would have the money taxed in their own hand as investment income.

The Chancellor said that Reits and similar property investment schemes would be eligible for inclusion in a Sipp. This means that every £100 of Reit income, plus any capital gain, would escape tax within the Sipp umbrella."

However, with the Chancellor's dithering track record on pension legislation to date, it would be wise to take this information with a pinch of salt.

There are still favorable rules for Income tax and Capital Gains Tax for holiday lets.

Holiday lets Tax update

Provided certain conditions are satisfied both the income from the property and any gain on the disposal of the property are favourably treated for tax purposes.

With one exception, the favourable tax treatment applies only if the let property is in the UK, The exception occurs in the case of a loan taken out to buy the property, where generous tax relief is available on holiday homes abroad as well as those in the UK (see below).

The commercial letting of furnished holiday accommodation is treated as a trade for tax purposes. This means that the profit counts as relevant income for tax relief on pension contributions.

Also, gains made on the disposal of the property may be rolled over into the cost of replacement premises. Thus, the sale of the cottage in Cornwall does not create a tax charge if all the proceeds are reinvested in, say, a log cabin in Scotland.

The business also qualifies for capital gains tax retirement relief (now being phased out) and holdover on the gifting of business assets, which means that the property may usually be gifted free of capital gains tax.

Should the venture be loss-making, it is possible to set the loss against other income for the same, or previous, tax years or carry forward for relief against future letting income.

It would be possible to use the property during any periods when it is not let, but the tax relief available may be reduced proportionately.

If a loan is taken out to acquire the property, the interest qualifies for full tax relief at your highest tax rate on the whole loan. A further capital gains relief called taper relief has been introduced in recent years and the amount you receive is calculated by reference to the number of years the property has been owned. the provisions are complicated, however, significant reliefs can accrue.

To obtain the favourable tax treatment, the property must be available for letting for at least 20 weeks in a tax year and actually commercially let for 10 weeks. The relief is intended for short lets only, so there is a further condition that the property is not normally let to the same person for more than 31 consecutive days in a seven month period.

Remember that increasing number of local councils charge Full Council Tax on vacant second properties.

Your Tax Return

The new tax rules regarding property rental income under Self Assessment apply from 6th April 1996.

The old and somewhat informal agreement between landlords and their local inspectors will no longer apply and all tax payers will now be required to operate under one set of rules when calculating their taxable property income.

Property income will now be treated like a business, using commercial accounting principles, with tax being calculated by reference to income and expenses relating to each tax year; payments actually received will apply to the period they relate to, not the date of receipt.

Accounts must be prepared for the actual tax year (6th April to 5th April) although the Inland Revenue have said that the are prepared to accept accounts made up to 31st March instead of the 6th April.

The tax payer has two choices: Lodge the return and a self assessment by 31st January following the end of year tax. Or: lodge the return by 30th September following the end of year tax and have the Revenue work out your tax liability.

• The new rules apply to both furnished and unfurnished lettings.
• Losses from one year can be carried forward to the following year.
• If you are in partnership, the same rules apply as with partnership trading income.
• Expenses incurred before and after trading (letting your property) can be claimed against income.
• The 'wear and tear' allowance of 10% presently available will remain in respect of furnished lettings.
• The full loan interest is now treated as a deductible expense.
• Capital allowances will be deducted as an expense in arriving at the taxable profit or allowable loss.
• The old Rules will continue to apply to UK Resident Companies.
• There are 'transitional' rules to avoid potential double taxation in the first year.
• Non UK resident landlords may apply to the Inland Revenue for rent to be paid Gross without Tenant or Agent deducting Tax.