How to calculate income tax on residential rent

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

10 July 2016

After the excitement about filing tax returns on the online platform, “i-tax” Joseph Ogolla says he came through feeling rather patriotic and decided to own up to the fact that he owns a rental house. He writes: “I was encouraged by the tax amnesty on rental income and decided that I have been in hiding long enough [three years]”

“I have now come clean but I’m a confused a bit by this new residential rent tax. Is it supposed to be 10 per cent of the total rent collected or the balance after expenses?”

The answer is simple: the new residential rent tax is a flat 10 per cent of the gross rent collected. The landlord is not allowed to deduct any expenses at all. It is similar to the Turnover Tax (TOT) that is for small traders – 3 per cent of gross sales.

Apart from the percentage rate, there is another major difference between these two taxes: while traders are allowed to opt-in the TOT, landlords are only allowed to opt-out. All landlords who gross rent from residential properties is less than ten million shillings per year are required to pay 10 per cent of their collection every month.

This is a very good deal for those whose properties are “mature” and do not have high operational costs; but it is bad for those with newly acquired houses that are likely to have very large amounts of financing costs.

The fact is that, a rental house bought through a mortgage makes big losses in the early years of the financing plan. Take the example of one that cost, say, Sh10 million. The typical rent collectable from such a residential property is about Sh75,000 per month.

If is bought with a mortgage charging 15 per cent per annum for 15 years, the monthly instalment would be about Sh140,000. Straight away, we see that the landlord doesn’t even get enough cash to repay the financier!

But that’s not what the taxman is interested in. One part of that Sh140,000 monthly instalment goes towards principal payment and the other is the finance cost; that is, the interest on the loan. Obviously, the principal payment is NOT a cost to the landlord! Only the interest is.

The interest for the first month is Sh125,000. The rent collected is Sh75,000. So the landlord incurs a loss of Sh50,000. It would therefore be totally unfair to expect such a person to pay any tax – assuming that this is the only source of income.

Obviously, the house cannot be the only source of income: that would leave us wondering how he is able to raise the other Sh65,000 required to pay the Sh140,000 to the bank! Still, it would only be fair that he is allowed to deduct this loss from his other income before calculating his final tax.

Despite the bad reputation that taxmen have, tax laws are largely fair. It is in that spirit of fairness that landlords are allowed to apply to opt out of the residential rent tax regime. But they must write to make the request.