How to avoid paying residential rent income tax

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

17 July 2016

Last week, we worked out that a newly acquired rental house is a loss-maker and, therefore, the landlord should not pay any tax on the rent. The numbers came out as follows: monthly instalment = Sh140,000; bank interest charged in the first month = Sh125,000; rent collected = Sh75,000; therefore, loss incurred = Sh50,000.

A few readers have asked whether it is possible for anyone to afford such a high amount of loan instalment. Let me turn the question around and find out what salary you need in order to be able to pay the Sh140,000 monthly loan instalment comfortably. There is a widely used rule of thumb: the total deductions from your salary (taxes, levies, loan payments etc.) should not exceed two-thirds of your gross earnings.

With that rule in mind, it turns out that you need a gross salary of at least Sh375,000 per month if you will comfortably afford the Sh140,000 loan instalment. With that income, your PAYE will be about Sh105,000. If you add this to the Sh140,000 loan instalment, the total is Sh245,000; leaving a balance of about Sh130,000 which is you net salary. Now two-thirds of Sh375,000 is Sh250,000; so you are within the maximum deductions limit.

Now it might seem quite reckless that you are earning Sh375,000 and getting just Sh130,000 as cash. But don’t forget that there is the Sh75,000 rent that you are getting each month. Thus you total net income is Sh205,000.

Going back to the loss-making house, it is clear that it wouldn’t be fair to expect the landlord to pay any tax. For that reason, I would advise any person in such a situation to immediately write to the Commissioner of Income Tax and request to be removed from the new residential rent tax.

There is another advantage of coming clean early: you get to carry forward the losses and you can off-set them against future profits. But, of course, you can only do this for the period that you have been declaring the rental income.

Assuming that you increase the rent by 10 per cent every two years, then, starting from this year (2016), the house will start making a profit in 2023 (yes; seven years from now)! In that year, the total interest will be Sh1,130,000. The rent will have climbed to about Sh110,000 per month so you will collect Sh1,320,000 in the year.

Thus your profit for 2023 will be Sh190,000. But remember, you will still be paying Sh140,000 for the loan; that is a total of Sh1,680,000 in the year. In other words, The rent collected (Sh1,320,0000 will be less than the money paid to the bank (Sh1,680,000)!

The Sh190,000 profit will attract income tax of Sh8,460. Unfortunately, you will not have the cash to pay it – at least not from the house. This is where the accumulated losses from the earlier years will come in handy: you can begin to offset them against the profit and therefore pay no tax.