Not too many people are aware of the tax implications of owning property in the UK, especially for the purpose of generating rental income.
However, there are ways you can legitimately reduce, or even pay zero income tax to eliminate these income tax liabilities. The most important thing is you first need to understand HMRC’s tax rules.
In this article, I will try to explore strategies, examples, and useful resources you can use to help you achieve this legally.
1. Use a Declaration of Trust to Split Rental Income
A declaration of trust allows those owning property to split rental income in proportions that are more tax-efficient, particularly between spouses or civil partners. Combined, you would pay zero income tax.
How It Works:
- The property must be jointly owned, either as joint tenants or tenants in common.
- A declaration of trust specifies how rental income is divided between owners.
- Income tax is then paid based on each owner’s share.
- If one of the spouses in the relationship is in a lower tax bracket (so under £12,570), you can take advantage of potential taxes by assigning a larger percentage of the rental income to them and therefore avoid a significant amount of total tax liability.
Breaking Down a Real Life Example:
Scenario: A couple who owns a buy-to-let property earning around £12,000 or more annually in rental income.
- Sample Situation: If Spouse A (a higher earner) is in the 45% tax bracket, and Spouse B (a lower earner) is a non-taxpayer (0% rate).
- Before a Declaration of Trust: Income is split 50:50:
- Spouse A pays 45% on £6,000 (£2,700).
- Spouse B pays 0% on £6,000.
- Total Tax Paid: £2,700.
- After a Declaration of Trust: Split adjusted to 90:10 in favour of Spouse B:
- Spouse A pays 45% on £1,200 (£540).
- Spouse B pays 0% on £10,800.
- Total Tax Paid: £540.
- Before a Declaration of Trust: Income is split 50:50:
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2. Operating Through a Limited Company
Owning property through a limited company can be highly tax efficient, especially for landlords who own multiple properties. As a director, you can benefit from strategic remuneration options, such as salaries and pensions. Although you would not pay zero income tax, you can significantly reduce it with this method.
Key Benefits:
- Rental income is subject to corporation tax, (which is 25% for companies with profits over £250,000). For companies with profits below £50,000, the rate remains at 19%. Profits between these thresholds are taxed at a marginal rate.
- Directors can receive a salary and pension contributions, which are deductible business expenses.
- Profits retained within the company can be reinvested without personal tax liabilities.
Important Caveat:
While retaining profits within the company can reduce immediate tax liabilities, withdrawing money (e.g., as dividends or salary) incurs personal tax charges. Dividend income is subject to dividend tax rates, and salaries are subject to income tax and National Insurance Contributions (NICs). These additional taxes should be carefully considered when deciding whether to operate through a limited company.
Withdrawing Money from a Limited Company:
- Salary: Paid as an expense, reducing the company’s taxable profits. However, salaries are subject to income tax and NICs.
- Dividends: Paid from post tax profits of the business. Dividends may be paid up to the annual allowance (£1,000 for 2024/25) are tax free; amounts above this are taxed at 8.75% (basic rate), 33.75% (higher rate), or 39.35% (additional rate).
- Director’s Loan: Withdraw funds from your business temporarily as a loan. Make sure you apply strict rules for repayment deadlines in order to avoid any additional tax costs.
Example:
Scenario: Lets say a property generates £40,000 in annual rental income, with £10,000 in allowable expenses. Breaking this down:
- Company Calculation:
- Rental Income: £40,000
- Expenses (including salary/pension): £15,000
- Taxable Profit: £25,000
- Corporation Tax (25%): £6,250
- Retained Profit: £18,750
- Personal Calculation (as a higher-rate taxpayer):
- Taxable Income: £30,000 (£40,000 – £10,000 on expenses)
- Income Tax (40%): £12,000
- Savings Through a Limited Company: £5,750.
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3. Utilising Rent-a-Room Relief
If you use “Rent-a-Room” relief, you could earn up to £7,500 tax-free per year as a homeowner by renting out a furnished room in your primary home residence.
Eligibility:
- The property must be your core primary residence.
- The rented room must be furnished.
- The scheme cannot be used for separate flats or self-contained units unless specific conditions are met.
Example:
Scenario: Lets say a homeowner earns £8,000 annually by renting out a room. Breaking this down:
- Taxable Income: £500 (£8,000 – £7,500 allowance).
- Basic-rate tax (20%): £100.
- Without the scheme, the entire £8,000 would be taxable to HMRC (£1,600 at 20%).
Caveats:
- Shared living areas (e.g., kitchen) are required for eligibility.
- Separate external entrances (e.g., for a basement flat) may disqualify the arrangement.
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4. Capital Allowances for Furnished Holiday Lets
Furnished holiday lets (FHLs) have an additional benefit of unique tax advantages compared to standard rental properties.
Benefits:
- You can claim capital allowances on furniture and equipment for setting up the property (which you could also sell later on).
- Profits are taxed as business income, allowing for more deductions.
- Qualifying FHL income may count toward pension contributions.
Example:
Scenario: Lets say a holiday let generates £20,000 annually, with £5,000 of that spent on new furnishings for the property. Breaking that down:
- Capital Allowance Deduction: £5,000.
- Taxable Income: £15,000.
- Income Tax (basic rate): £3,000.
- Finally: Without the allowance, tax liability would be £4,000.
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Recommendations
For more specific guidance on how to pay zero income tax as a property owner, seek the advice of a tax professional or utilise specialist services such as TaxScouts to guarantee tax compliance while optimising your tax savings. Tax legislation and allowances can always be amended, so obtaining professional advice is essential.
By leveraging these strategies, you can legally minimise (or even eliminate) income tax liabilities on your property while remaining fully legal compliant with HMRC regulations.
If you liked my article about income tax, you might also like this other article about reducing your capital gains tax.
