Tax Law Letter Mr. And Mrs. Bob

Tax Law Letter

Mr. And Mrs. Bob and Anna Diamond

I would like to start by thanking you for entrusting me with guiding you as you plan this next phase of your financial growth. Tax considerations are an important part of ensuring your financial independence and security at any time, and after retirement they can become some of the most significant factors and forces of change in a family's financial position. It is wonderful that you are pursuing your various options in such a considered and careful manner, and I am more than happy to help you in this process of growth and change in your lives.

It is my understanding that you are considering several different property purchases and other methods for generating income through the renting of properties you do or will own. Specifically, you are exploring the possibilities of letting out rooms in the house that you currently occupy, during school terms and on a non-renewing basis; furthermore, you are also considering the purchase of a seaside cottage to be let out on a short-term basis to holiday makers; finally, you are seeking to purchase several standard housing units for long-term rentals to residential tenants. It is also my understanding that these purchases will be made largely or entirely with cash already in your possession, primarily from an inheritance received following the passing of a relative. If I have erred in my assessment of your situation and considerations, please do let me know right away, as any change could affect the reliability of the information I can impart to you.

There are three distinct types of property purchases and rental schemes that you are exploring, and each of them is treated differently for tax and income purposes. Some of the laws regarding rental income taxes and general property taxes will be applicable in more than one of these areas, but overall tax liabilities and structure vary from standard residential rentals (i.e. The long-term tenant-occupied properties you are considering), furnished holiday rentals (assuming you plan on furnishing the seaside cottage you will be renting to holiday makers, which is pretty much a necessity in order to actually find tenants), and renting rooms in an owner-occupied home. By considering each of these specific areas separately, you will gain a better understanding of the tax liabilities for each specific type of property investment, and will be better able to select a mix that works for your situation and goals.

Residential Lettings

The income obtained from standard long-term residential rentals has a specific tax structure in the United Kingdom, generally treating any profits received from the business simply as additional income taxed at the same rate as your normal income. For residential lettings of this type, all properties are considered part of the same business, and thus contribute to the same income. This also means that losses from one property can be used to offset profits on another property, meaning taxes will only be assessed on total overall profits.

There are certain complications to the taxes assessed on rental property income, however, and it is through an understanding of these complexities that savings can be generated in this particular scenario. Specifically, understanding the allowable expenses from income received through letting can greatly reduce the tax burden that you will incur form this income. When calculating the net profit obtained fro rental income, there are several areas where deductions can be made before the income is started as profit. These deductions represent the greatest tax savings, as they are removed before the income from letting properties is ever even counted as income by Revenue. Other expenses related to letting can be listed as tax allowances, but this occurs after these amounts are counted as income and thus are not as beneficial from a tax savings perspective.

Allowable deductions before letting income is counted as profit include letting agent's fees, legal fees incurred for lets of a year or renewals (as long as the terms of the lease are for a period of less than fifty years), accountants fees, insurance, interest on loans, maintenance and utility payments, Council Tax, and a list of other specific direct costs. Some of these expenses are less applicable to your situation than others, but you should consider these options carefully; it might be to your advantage to fund your property purchases through the use of borrowed funds, as the interest is tax deductible and could allow for more purchases and greater profitability, for instance.

Allowances for capital costs -- indirect costs associated with letting properties -- can also be deducted from the final taxed amount, though the savings here are not as significant for these costs. Generally speaking, fifty percent of capital costs such as construction of new properties or additional property, new machinery or equipment, and supplies used for maintenance activities like gardening and cleaning can be deducted. For certain qualifying environmentally friendly purchases, one hundred percent of capital costs can be deducted from the tax amount, but these are very special cases and must be items specifically approved for this full allowance in order for the one hundred percent deduction to apply instead of the standard fifty-percent. Wear and tear allowances on the property itself, in amounts based on specific percentages of the rent being charged and property features, can also be deducted.

Furnished Holiday Lettings

There are several key differences between the letting of furnished holiday rentals on a short-term basis and the letting of residential property for the sole use of someone's home that can create additional tax savings for holiday rentals. One major example of such a difference is the ability to deduct the cost and depreciation of furnishings as capital costs deducted prior to the calculation of overall profit. Instead of simple wear and tear deductions such as are allowed for residentially let properties, these costs can be capitalized and given dollar amounts in their own right rather than simply being calculated as a percentage of the rent being charged. Other capital allowances that are given tax allowance for standard residential properties are deductible from income for furnished properties let for holidays. Losses for properties let as holiday rentals can be used to offset property from other income in the same manner as losses from standard residential properties, yet losses from holiday lettings can also be carried forward to offset profits in future years in addition.

In order to qualify for the tax advantages specific to holiday lettings, certain criteria must be met. The property must be available for commercial letting to the public for at least one hundred and forty days during any year for which these deductions and advantages are applied, and it must actually be let at market rates for seventy days in the year. The property can be let to the same person multiple times during a single year, but no period can be longer than thirty-one days. Any period of letting that extends beyond a thirty-one day limit does not apply towards the one hundred and forty or the seventy day requirements, and the property cannot be let to the same person -- continuously or in different periods -- for more than one hundred and fifty-five days in any given year. If these conditions are broken, the property will be treated as a standard residentially let property for tax purposes.