THE taxman declared war on amateur landlords last week, sending out hundreds of letters to investors who it thinks are not declaring enough tax on their buy-to-lets. This is just the beginning of what is expected to be a wide-ranging crackdown, with thousands likely to be targeted over the next year.

Accountants are concerned that landlords who have quite innocently failed to pay the correct tax could be caught up in the campaign and be subjected to prosecutions and fines.

Chas Roy-Chowdhury at the Association of Chartered Certified Accountants said: “Tax rules for renting out property are confusing and it’s easy to make a mistake.”

The first Revenue letters are being targeted at landlords suspected of renting out property without declaring the income. Accountants say many people, especially those who are not charging much rent, may be unaware that the income should be declared even if no tax is due.

The taxman also has his eyes on property investors who fill in a return but are underdeclaring what they owe. The Revenue is concerned that many landlords with repayment mortgages are breaking the rules by claiming too much tax relief.

The crackdown is the culmination of a year-long campaign to track down property investors who have been underdeclaring tax. Inspectors have been using a sophisticated computer system to trawl through letting ads and a telephone whistleblower line.

Peter Goodman at accountant Wilkins Kennedy said: “Until now inquiries have been pretty piecemeal, so this is a real change in tactics. People who refuse to cooperate could ultimately face criminal prosecution.”

A typical buy-to-let investor with mortgage firm Paragon and a portfolio of 11 properties is pocketing about £110,000 a year before expenses – about £10,000 a property.

The Revenue is asking taxpayers to come clean about their property income and expenses for the past six years. Anyone found to have underdeclared could face penalties and interest charges plus a bill for unpaid tax.

Even if you have been declaring and paying tax, it is easy to trip up because the rules are so complex. Recent scandals have helped to muddy the water, including that of James Purnell, the pensions secretary, who claimed his second property as his principal private residence to save capital-gains tax (CGT). Here we explain the rules.

Offset your income

Rent is subject to income tax, and if one spouse is a basic-rate taxpayer it makes sense to have it in his or her name until you want to sell, so you pay less income tax.

The interest you pay on your mortgage can also be set against your tax bill. If you have an interest-only mortgage you can offset all your monthly payments. With a repayment loan, however, part of your monthly mortgage payment goes towards repaying the capital. You must offset only the interest element.

You can also get relief on maintenance bills, council tax, water and sewerage rates. All these can be knocked off your income, so keep the receipts.

Nominate the property as your main home before you sell

Purnell, a rising cabinet star, has unwittingly helped to highlight a little-known perk that can help you avoid a huge bill on the sale of a buy-to-let or holiday home.

This allows you to nominate a second home as your main property so it is liable for less CGT when you sell.

Purnell has been heavily criticised for using the perk because he also claimed £20,000 a year in parliamentary allowance on the same property. But accountants say that should not stop ordinary taxpayers from following his lead.

To profit from the perk you must elect your main home as your principal private residence (PPR) within two years of buying another one.

Any house purchase can be used as the basis of an election. If you bought a buy-to-let five years ago you might think you would be out of time. But if you moved house or bought another second property less than two years ago, you could use that to make an election. It doesn’t matter whether the property is in the UK or overseas.

Once you have done it, you can alter your choice when you wish. By switching the nomination to the second property and living in it for a while, you will not be liable for CGT for the last three years of ownership.

Say you wanted to sell the second property after 10 years of ownership and it has risen in value by £100,000. Normally, CGT would be calculated on the £100,000 gain, but if you nominated it as your PPR, the last three years would be CGT-free, meaning your tax bill would be based on £70,000. After April 5, you will pay 18% tax on the increase, so this manoeuvre will save you just over £5,000 in tax.

Matt Coward at Blick Rothenberg, an accountant, said: “All you need to do is write a letter to your tax inspector within two years of purchasing a property, nominating your main home as your PPR. You can subsequently send in another letter specifying a second property as your PPR instead.”

You must get the timing right because your family home will become liable for tax. It often makes sense to do it just before you sell your second property. Once you have sold, you reelect your other home.

For a second property to qualify as your PPR, the Revenue’s rules state that you have to live there for a minimum of a week. However, accountants say it is safer to move into the property for at least six months. You may also be required to provide evidence that you used it as your main home, such as bank and credit-card statements that include the address.

Use both allowances

If you are married, transfer half the property into your spouse’s name before the sale so you use two capital-gains allowances. This year the first £9,200 of profit per person is free of CGT. In the scenario above, where you are liable for tax on £70,000 it could cut your gain to £51,600.

Claim letting relief

If you own a buy-to-let, you may also qualify for letting relief if you lived in it at some point. This is a very valuable tax break, as it is worth £40,000 per owner. A husband and wife who own a property jointly could claim lettings relief of up to £80,000. In the above example, using all three reliefs would wipe out your gain.

Buy through a trust

Parents who buy a property for their son or daughter to live in at university can reduce the CGT by purchasing it through a trust. The parents can be trustees and write a clause in the deed that entitles their child to live in the house rent-free. If you buy via a trust you qualify for PPR relief without affecting relief on your main home. However, if the property is rented out to other students, you will not get 100% relief.

HOW TAX RELIEF ON INCOME WORKS

- Someone with a buy-to-let loan of £100,000 over 25 years at a rate of 6% would pay £500 a month on interest-only. If they received £850 in rent, tax would be payable on £350 (£850 less £500).

- A higher-rate taxpayer would therefore pay £140 a month in tax – £1,680 a year.

- If the borrower had a £100,000 repayment mortgage, however, the monthly repayments would be £644, of which £496 would initially repay interest and the rest would go towards the capital.

- The interest element falls year on year as capital is repaid, so the tax relief will also decline. After 20 years, although the repayments would still be £644, only £181 of that would be interest.

- Assuming the rent stayed at £850, £669 would be liable to income tax, costing a higher-rate payer £268 a month, or £3,216 a year – £1,536 a year more than if the mortgage was interest-only.

RULES TOO COMPLICATED, SAYS LANDLORD

MARY ANN PEARCE, a landlord from Dulwich in south London, doesn’t take any chances with her tax bill. Ever since she let out her first property about 16 years ago she has relied on an accountant to deal with the tax system.

Pearce, 44, who has run her own property business for a decade and has six properties around Dulwich, said: ‘I am a representative for the National Landlords Association and in my role help out other investors.

‘Landlords with a capital repayment mortgage often assume they can offset all of their mortgage payments against tax but they should only be claiming for their interest payments [see panel],’ she said.

‘It’s no surprise, as the system is hideously complicated.’