Property investors need to know if rental income is taxed at 40%.
This is a question we get asked all the time, and the short answer is ‘no’. The rate of tax you pay depends on your overall level of income, from all sources. Like any other income rental profits can get taxed at 0%, 20%, 40% or even 45%.
Let’s take a look, in the latest of our Property Investing 101 series.
The main UK income tax bands for the current tax year (2022/23) are:
| Income range | Rate of tax |
| 0 – 12,570 | 0% |
| 12,571 – 50,270 | 20% |
| 50,271 – 150,000 | 40% |
| Over 150,000 | 45% |
To complicate matters there are additional tax-free bands for some income, dividends are taxed at different rates and there are variations in Scotland and Wales.
In practice you could have two sources of income, say a salary of £30,000 and rental profits of £10,000. This would give you the following:
- First 12,570 @ 0 % = £0
- Next 27,430 @ 20% = £5,486
- Total 40,000 = £5,486
However, what has changed in recent years is that tax relief on mortgage interest is now only given at 20%, even if your income is being taxed at 40%. What’s worse is that the profit is calculated before the interest is deducted as an expense. This means that you could be pushed into the higher-rate tax bracket, even if your actual profit is quite low.
In our example, let’s assume that the £10,000 of rental profits is after deducting mortgage interest of £15,000. Under the new system the taxable profit is now £25,000 (10,000 + 15,000). The tax calculation now looks like this:
- Salary 30,000
- Rental 25,000
- Total 55,000
There is now £4,730 being taxed at 40%:
- First 12,570 @ 0 % = 0
- Next 37,700 @ 20% = £7,540
- Next 4,730 @ 40% = £1,892
- Total 55,000 = £9,432
- Less (15,000) @ 20% = £3,000 (this is the tax relief on the mortgage interest given at basic rate)
- Final 40,000 = £6,432
These means that the taxpayer is paying more tax for the same income under the new system compared to the old, which is why many landlords are switching to limited companies. Limited companies pay tax at 19%, no matter what the level of income.
If you would like more information on this or any other tax matter please get in touch.