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How to Avoid Paying Tax on Rental Income in the UK

Owning rental property in the UK can be a great way to generate extra income, but with it comes the responsibility of paying taxes. However, there are legal ways to reduce the amount of tax you pay on rental income, making the process a little less painful. If you’re a landlord or thinking of becoming one, this guide will show you some smart strategies to help keep more of your hard-earned income in your pocket, without running afoul of HMRC.

1. Offset Expenses: Claiming Deductions You’re Entitled To

When you’re renting out property, one of the best ways to reduce your tax bill is by offsetting your rental income with allowable expenses. These expenses must be directly related to the letting of the property, and some common examples include:

• Maintenance and Repairs: You can claim for the cost of repairing and maintaining your rental property. This includes things like fixing a leaky roof, repainting walls, or replacing a broken boiler.
• Property Management Fees: If you use a letting agent to manage your property, the fees you pay them can be deducted from your rental income.
• Utility Bills and Council Tax: If you cover these costs for your tenants, you can deduct them when calculating your taxable rental income.

However, it’s important to remember that capital improvements (like building an extension or upgrading the kitchen) cannot be claimed as expenses against your rental income, though they may reduce your capital gains tax when you sell the property.

2. Take Advantage of Mortgage Interest Relief Changes

In recent years, there have been significant changes to how mortgage interest relief is handled in the UK. Landlords used to be able to deduct their mortgage interest costs from their rental income, but this has been replaced by a tax credit system.

Now, landlords can claim a 20% tax credit on mortgage interest payments. This is less beneficial than the old system, especially for higher-rate taxpayers, but it’s still an option that should be utilized to reduce your tax bill.

While the full deduction of mortgage interest is no longer allowed, you should still take this tax credit into account when planning your finances.

3. Use the Rent-a-Room Scheme (If You Live in the Property)

If you rent out a room in your main residence, you can take advantage of the Rent-a-Room Scheme. Under this scheme, you can earn up to £7,500 per year tax-free by renting out a furnished room in your home.

There are a few rules to bear in mind:

• The property must be your primary residence.
• The income must come from renting out part of your home, not a separate property.

This is a great way to reduce your tax liability if you’re sharing your space, and you don’t need to complete a tax return if your income stays within this threshold.

4. Joint Ownership: Splitting the Income for Lower Tax Rates

If you own the rental property with your spouse or partner, you can split the rental income between you for tax purposes. This works especially well if one of you is in a lower income tax bracket than the other.

For example, if one partner is a basic-rate taxpayer and the other is a higher-rate taxpayer, the partner with the lower income can declare more of the rental income. This results in a smaller overall tax bill. To achieve this, the property must be jointly owned, and you may need to file a Form 17 with HMRC to notify them of the split.

5. Maximise Capital Allowances on Furnished Properties

If your rental property is fully furnished, you can claim capital allowances on certain items that you purchase to kit it out. This includes furniture, appliances, and even some fixtures like carpets and curtains.

Though the Wear and Tear Allowance was scrapped in 2016, landlords can now claim the actual costs of replacing furnishings, which can reduce your tax bill significantly. Keep in mind that only replacements are eligible for deduction, not initial purchases when setting up the property.

6. Consider Incorporating Your Rental Business

For landlords with multiple properties or those generating significant rental income, incorporating as a limited company may be a tax-efficient option. There are a few key advantages to doing this:

• Corporation Tax: Rental income in a company is subject to corporation tax, which is currently 19%, as opposed to personal income tax rates which could be as high as 45%.
• Retaining Profits: If you don’t need to withdraw the rental income right away, you can leave it in the company, paying the lower corporation tax and only paying personal income tax when you take money out (e.g., through dividends or salary).

However, incorporating comes with additional costs and complexities, so it’s not the right choice for every landlord. It’s worth discussing with an accountant to see if this is the best route for your rental business.

7. Take Advantage of Capital Gains Tax Reliefs

When you eventually sell your rental property, you’ll be liable for Capital Gains Tax (CGT) on any profit you make. Fortunately, there are ways to reduce this tax:

• Private Residence Relief: If the property was your primary residence at any point during ownership, you may qualify for Private Residence Relief, which can significantly reduce your CGT liability.
• Lettings Relief: Though scaled back, some landlords can still claim Lettings Relief if they rented out a property that was once their main home.

Planning ahead and understanding how CGT works will help you avoid a large tax bill when it comes time to sell.

Final Thoughts: Plan and Be Prepared

Reducing your tax liability on rental income isn’t about cutting corners or hiding income—it’s about knowing the rules and using them to your advantage.

From claiming expenses to considering incorporation, UK landlords have plenty of options to keep their tax bills as low as possible, legally and transparently. The key is to stay organized, keep detailed records, and ensure that you understand the deductions and reliefs available to you. Working with a professional accountant who understands the complexities of rental income tax can make all the difference, ensuring you don’t miss out on valuable tax-saving opportunities.