“I wasn’t making any money from the rental property. The rent was basically covering the mortgage.”
This is something I hear from landlords more often than you might expect.
And it is easy to understand the thinking.
Perhaps your tenant paid £1,200 a month and your mortgage was around £1,000. Once you had paid the mortgage, insurance, repairs and other property costs, there was very little left.
Or perhaps there was nothing left at all.
So, from your point of view, you weren’t making money from the property.
But there is an important difference between the cash you have left after paying the mortgage and the way rental profit is calculated for tax purposes.
And that difference can sometimes mean a landlord has a tax position to deal with even though they never felt as though they were making a profit.
Your mortgage payment is not the tax calculation
Suppose you receive £1,200 a month in rent.
That’s £14,400 over the year.
Your mortgage costs £1,000 a month, so £12,000 leaves your bank account over the same period.
It would be very easy to look at those two figures and think:
£14,400 rent less £12,000 mortgage = £2,400.
Then, once you’ve paid the other property costs, perhaps you conclude that you’ve made nothing.
But that’s not how the rental-property tax calculation necessarily works.
Your mortgage payment can include two very different things:
- repayment of the money you borrowed
- interest charged by the lender
Repaying the capital you borrowed is not an allowable expense that you simply deduct from your rental income.
So if a significant part of that £1,000 monthly mortgage payment is capital repayment, the fact that the money has physically left your bank account doesn’t mean it reduces your taxable rental profit.
HMRC specifically states that the full mortgage payment cannot be claimed when calculating rental profits.
What about the mortgage interest?
This is where it becomes slightly more complicated.
For individual landlords with residential property, the tax treatment of mortgage interest and other qualifying finance costs changed from April 2017.
The restriction was introduced gradually and has applied in full since 2020/21.
Under the current rules, qualifying residential finance costs are generally not deducted from rental income when calculating the taxable rental profit. Instead, relief is normally given through a basic-rate tax reduction, subject to the relevant conditions and limits.
This is one reason why simply looking at the mortgage payment on your bank statement can give you the wrong impression of your tax position.
Your cash position and your tax position are two different calculations.
“But I genuinely had nothing left”
You might be reading this thinking:
“That’s all very well, but I genuinely wasn’t making money. Every month the rent came in and went straight back out.”
And that may be completely true from a cash-flow perspective.
You may genuinely have had very little disposable cash from the property.
But that doesn’t, by itself, tell us whether there was taxable rental profit.
To establish that, we need to look at the rental income and the costs that the tax rules actually allow us to take into account.
Depending on the circumstances, allowable expenses can include costs such as letting-agent fees, insurance, repairs and maintenance, service charges and certain other costs incurred in running the property.
That calculation may produce a profit.
It could also produce a loss.
But we need to do the calculation before we know the answer.
Related reading
If you’re unsure which property costs can actually be deducted, read our guide to Landlord Expenses: Just Because You Paid for It Doesn’t Mean It’s Tax Deductible.
What if there really was no tax to pay?
This is another important distinction.
Finding out that rental income should have been considered does not automatically mean that you will have a large tax bill.
Your position will depend on the actual figures and circumstances for the relevant tax year.
That includes your rental income, allowable expenses, qualifying finance costs, other taxable income, available allowances and, where relevant, property losses.
HMRC calculates property-business profit by bringing together the rental income and allowable expenses, and losses can in some circumstances be carried forward against future profits from the same property business.
So the right question isn’t:
“Did the rent cover my mortgage?”
It is:
“What was my actual tax position?”
Those aren’t necessarily the same thing.
How one year can quietly become several
This is where I see the issue becoming particularly important.
Imagine you rent out a property for the first time.
You didn’t necessarily buy it intending to become a landlord. Perhaps it used to be your home.
The rent comes in.
The mortgage goes out.
There isn’t much left.
So you don’t think there is anything to deal with.
Then the following year looks much the same.
And the year after that.
Nobody contacts you about it, and because nothing has changed from your point of view, you continue on the same basis.
Five or ten years later, somebody asks:
“Have you been reporting the rental income?”
And suddenly the question isn’t about one year anymore.
This is how some historic rental-income cases arise.
It isn’t always someone deliberately deciding not to tell HMRC about their property.
Sometimes the starting point was simply an assumption:
“I wasn’t making any money because the rent was paying the mortgage.”
Related reading
If you’ve realised that rental income from previous years may not have been reported, read What Happens If Rental Income Was Never Reported? (UK Landlords Guide) to understand what this could mean and the next steps.
Did you need to tell HMRC?
This needs to be considered separately from whether you ultimately have tax to pay.
For individuals, HMRC currently provides a £1,000 property allowance in qualifying circumstances. Where annual gross property income is £1,000 or less and the allowance applies, there will generally be no requirement to tell HMRC about that income.
Above that level, reporting requirements depend on the amount of property income and the individual’s circumstances. HMRC’s current guidance says that gross property income over £1,000 generally needs to be declared, with different routes depending on the amount involved.
So “I didn’t have any money left after paying the mortgage” isn’t, by itself, the test for whether anything needed to be reported.
And if you’re looking at historic years, remember that the rules applying to each particular tax year need to be considered. The £1,000 property allowance, for example, only applies from 2017/18 onwards.
What should you do if you’ve used this assumption for several years?
First, don’t try to estimate the tax bill based simply on the amount of rent you received.
And don’t assume that every year will produce the same result.
The sensible starting point is to establish, year by year:
What rental income did you receive?
What allowable expenses did you incur?
What were the qualifying mortgage finance costs?
What other income did you have?
Which tax rules applied in that particular year?
Once those figures are established, you can work out whether there was a profit or loss and what, if anything, should have been reported.
If previous rental income should have been reported but wasn’t, HMRC has a process for disclosing unpaid tax on property income, including through the Let Property Campaign where appropriate.
Prefer to watch?
In this video, I explain why the mortgage payment leaving your bank account isn’t necessarily the amount you can claim when calculating rental-property tax:
Watch: Mortgage Payments on a Rental Property: What Can You Actually Claim?
The important distinction
If there’s one thing to take away from this article, it’s this:
Cash flow is not the same as taxable rental profit.
You can have very little money left in your bank account after paying the mortgage and other property costs and still have a rental tax position that needs to be considered.
Equally, discovering that you should have looked at the rental income does not automatically tell us that tax is due.
The figures need to be calculated properly.
If you’ve been renting out a property and haven’t reported the income because you believed the rent was simply covering the mortgage, Grace Certified Accountants can help you establish the correct position.