Landlords who have sold a rental property but failed to declare the profit to HM Revenue & Customs are being targeted in a new crackdown on tax evasion.
Using Land Registry records, HMRC's "property sales" campaign aims to recover millions of pounds of unpaid capital gains tax from landlords and others who have sold second or holiday homes. People who come forward and settle their liabilities by September will be charged lower penalties than those subsequently caught by the taxman.
Officials are also threatening action against what they see as the "bigger risk" of landlords not declaring rental income, which costs the public purse at least £550 million a year in lost tax.
But while HMRC steps up its efforts to tackle evasion, accountants point out that there are still plenty of legitimate ways to cut or even eliminate tax bills on rental properties.
Landlords can offset a range of expenses against rent they receive, while for those selling a rental property that has previously been their main home there are a number of reliefs that can substantially cut capital gains tax bills.
"The rules are generous," said Tim Norkett, head of private clients at accountants Crowe Clark Whitehill.
For many landlords, mortgage interest is their biggest tax-deductible expense. One recent analysis calculated that the tax savings from this relief were worth an average of £1,400 a year per buy-to-let property.
Only the interest — not the capital element of repayments — can be set against rental income. However, the relief can be claimed even if the mortgage on the rental property is a traditional residential loan — it does not have to be a specialist buy-to-let mortgage.
Repairs and maintenance, including decorating, can also be charged against rental income. However, claims that go beyond "like-for-like" replacements may be deemed by HMRC to be "improvements", which are generally only chargeable against the capital gain on a property when it is sold — a less favourable relief in most cases.
Norkett said that replacing an old kitchen, so long as the cost isn't high, should be permitted as a rental expense. Installing a luxury bathroom, however, may need to be set against the capital profit.
He added that high claims for repairs are the area of rental expenses that HMRC most commonly challenges. For landlords who let furnished properties, a wear-and-tear allowance of 10 per cent of the annual rent can also be claimed.
HMRC figures show that overall, landlords claim expenses totalling more than half of rents — significantly reducing the amount of tax payable. And where a landlord's expenses are higher than the annual rent they receive, this "rental loss" can be carried forward to reduce tax in future years. Capital gains reliefs can also dramatically shrink tax bills for some landlords when they sell a rental property at a profit.
Where a rental property has at any point been the landlord's main home, the last three years before the sale are exempt from capital gains tax. The period when the property was the landlord's main home is also capital gains tax-free. Additionally, so-called "letting relief" can reduce the remaining gain by up to another £40,000.
Landlords looking to sell a property they have not previously lived in may also be able to benefit from the three-year capital gains tax exemption by "electing" to make it their main home.
This can be particularly beneficial where a rental property has only been owned for a few years but its value has increased a lot, said Francis Kershaw, partner at Whins Associates, a tax adviser.
The election is made by writing to HMRC, though Kershaw emphasised that the landlord would also need to genuinely move into the property to qualify for the tax break. And landlords should be warned that HMRC may challenge the claim for relief.
* For more details of HMRC's property sales campaign, call 0845 601 8819 or visit hmrc.gov.uk/campaigns
The tax-break checklist
TAX-deductible rental expenses include:
* Mortgage interest (but not capital repayments)
* The cost of a letting agent, legal and other management fees
* Repairs and maintenance
* A wear-and-tear allowance of 10 per cent of rental income each year for furnished properties
Capital gains tax exemptions:
* Cost of property improvements
* The last three years of ownership plus the period that the property was the landlord's main home, plus letting relief of up to an additional £40,000 — all for properties that have been the landlord's main home at some point.