Landlords beware: an increase in rent can reduce your income!

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

08 January 2017

For reasons of confidentiality, “John” would like to remain anonymous, but he asks a pertinent question that probably affects many other people. He says that he owns some “executive houses in Nairobi” from which he collects a total of Sh800,000 rent per month.

He continues: “As a patriotic citizen, I registered all of them with the Kenya Revenue Authority [KRA] and, since the beginning of 2016, I have been paying the residential rent income tax of 10 per cent. I was advised by KRA that this was the best for me since the annual collection is less than Sh10 million…”

John adds: “My problem is that some of the tenants are due for rent review and I expect the total collection to exceed Sh10 million in 2017. In that case, I will no longer qualify for the special 10 per cent tax. I will have to pay almost 30 per cent and so my net income will reduce even though the rent I collect will be higher. Do you have a suggestion on how I can safeguard myself without breaking the law?”

First of all, let me explain the basis of John’s worries: landlords who collect less than Sh10 million per year from residential houses are taxed at a special flat rate of 10 per cent on the gross rent. Those who feel that this is unfair – perhaps because their houses are loss-making – can apply to KRA to be returned to the normal income tax regime.

So, John’s residential rent of Sh800,000 per month, or Sh9.6 million per year, attracts a total annual tax of Sh960,000. This leaves him with Sh8,640,000. But he incurs some operating costs to take care of cleaning, repairs, agency fees, security, etc. Let’s allow about 15 per cent of gross rent; that is Sh1,440,000 per annum. Thus his net income is Sh7,200,000.

Now, suppose John increases the rent by, say, 10 per cent from the current Sh800,000 to Sh880,000 per month. The total annual rent jumps to Sh10,560,000. He is now required to do normal profit / loss calculations and then work out the income tax on the profit.

If we allow the same 15 per cent operating costs, we find that his annual profit is Sh8,976,000 per year. The tax payable for this profit is Sh2,612,687. I have calculated this using the tax brackets of an individual taxpayer and also subtracted the personal relief.

Subtracting this tax from the profit leaves John with a net income of Sh6,363,313. This is Sh836,687 less than what he was earning when the rent was lower. This is not a small difference; it is 11.6 per cent less.

To emphasise: John increases the rent by 10 per cent but his income decreases by 11.6 per cent! It is a strange state of affairs and landlords need to be careful when increasing rents lest they end up with lower income.

So what’s John’s solution? We shall discuss it next week.