Rental Property Tax Treatment
Landlords with tax considerations in both the US and UK may be required to report income associated with rental properties in both jurisdictions. Each country has its own set of rules and regulations regarding the tax treatment and reliefs available with such income. For more information on which jurisdiction has the primary right to tax your rental profits, see Where do I pay tax?
Expenses and Deductions
For the most part, allowable rental expenses and deductions in the US and UK follow the same rules (some exceptions apply). A key exception to this is mortgage interest. Mortgage interest is fully deductible as an expense for US tax purposes; however, for UK tax purposes, all financing costs, including mortgage interest, must be claimed as a basic rate tax reduction (for 2020/21 onwards) rather than as a direct expense.
Repayments of mortgage capital or principal are not deductible against rental income in either the US and UK.
Depreciation
Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over time. The US and UK each handle depreciation in a different way. US taxpayers with rental income generally have a legal obligation to depreciate large capital expenditures associated with the property year-on-year; for example, the cost of the building itself, as well as any improvements, furniture, or fittings. Depreciation allows the cost of such expenses to be deducted bit-by-bit across the useful life of the asset, reducing taxable rental income in each year. However, depreciation also reduces the taxpayer’s basis in the asset, which may be subject to recapture rules when the asset is sold or otherwise disposed of. This would mean that any taxable gain incurred when the asset is disposed of is increased.
Conversely, the UK does not generally allow any sort of depreciation deduction against rental income for Self-Assessment taxpayers, which means that the base cost of a rental property for UK tax purposes will usually be the same as its original purchase price. As a result, the sale of a rental property can potentially cause a much larger immediate tax liability in the US than in the UK, leaving taxpayers with a shortfall of UK foreign tax credits to utilize against their US tax liability. As such, careful tax planning is essential to minimize the tax risks associated with the sale of rental property.
Sale of Rental Property
Both the US and UK provide for special tax reliefs available to homeowners on the sale of their personal residence (the Section 121 Exclusion in the US, and Private Residence Relief (PPR) in the UK). See the Sale of Home section of our website for more information. Rental properties that were once your principal personal residence may still qualify for full or partial relief under both tax systems, provided you still meet the required tests in each jurisdiction.
In the US, any gain that is not excluded under Section 121 can potentially be deferred in a Section 1031 exchange, where the rental property is exchanged for another rental property. This can create a potential tax liability in the UK, however, where deferring the gain in such an exchange is not recognized, thereby effectively negating the tax benefits of a Section 1031 exchange for dual US/UK taxpayers.
Expenses and Deductions
For the most part, allowable rental expenses and deductions in the US and UK follow the same rules (some exceptions apply). A key exception to this is mortgage interest. Mortgage interest is fully deductible as an expense for US tax purposes; however, for UK tax purposes, all financing costs, including mortgage interest, must be claimed as a basic rate tax reduction (for 2020/21 onwards) rather than as a direct expense.
Repayments of mortgage capital or principal are not deductible against rental income in either the US and UK.
Depreciation
Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over time. The US and UK each handle depreciation in a different way. US taxpayers with rental income generally have a legal obligation to depreciate large capital expenditures associated with the property year-on-year; for example, the cost of the building itself, as well as any improvements, furniture, or fittings. Depreciation allows the cost of such expenses to be deducted bit-by-bit across the useful life of the asset, reducing taxable rental income in each year. However, depreciation also reduces the taxpayer’s basis in the asset, which may be subject to recapture rules when the asset is sold or otherwise disposed of. This would mean that any taxable gain incurred when the asset is disposed of is increased.
Conversely, the UK does not generally allow any sort of depreciation deduction against rental income for Self-Assessment taxpayers, which means that the base cost of a rental property for UK tax purposes will usually be the same as its original purchase price. As a result, the sale of a rental property can potentially cause a much larger immediate tax liability in the US than in the UK, leaving taxpayers with a shortfall of UK foreign tax credits to utilize against their US tax liability. As such, careful tax planning is essential to minimize the tax risks associated with the sale of rental property.
Sale of Rental Property
Both the US and UK provide for special tax reliefs available to homeowners on the sale of their personal residence (the Section 121 Exclusion in the US, and Private Residence Relief (PPR) in the UK). See the Sale of Home section of our website for more information. Rental properties that were once your principal personal residence may still qualify for full or partial relief under both tax systems, provided you still meet the required tests in each jurisdiction.
In the US, any gain that is not excluded under Section 121 can potentially be deferred in a Section 1031 exchange, where the rental property is exchanged for another rental property. This can create a potential tax liability in the UK, however, where deferring the gain in such an exchange is not recognized, thereby effectively negating the tax benefits of a Section 1031 exchange for dual US/UK taxpayers.
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