Tax on Rental Income | 5 Rules You Must Know If You Rent out a Property in Malaysia
Question:
‘Hi, I’m Adam. I earn a monthly rental income of RM 14,000 from my properties. I have an outstanding mortgage of RM 600,000 where its monthly repayment is RM 10,000. How is my monthly income calculated for paying tax on rental income?’
Are you going to declare your rental income to LHDN? Read this: 8 Things to Be Aware off When Declaring Your Rental Income to LHDN
Answer:
The answer is not as straightforward. Several factors affects the computation of Adam’s final chargeable tax on rental income and tax payments. They are as follows:
1.Deductible Expenses
First, We’ll provide a list of both deductible and non-deductible expenses incurred in the course of generating tax on rental income. Deductible expenses are costs which can be used to subtract gross rental revenues to derive one’s net rental income. They are as follows:
| Deductible Expenses | Non-Deductible Expenses |
|---|---|
| – Interest on Mortgage / Loan – Assessment and Quit Rent – Fire Insurance Premiums – Rent Collection Fees – Expenses to Renew Tenancy Agreements – Expenses to Replace Tenants – Repair and Maintenance Costs | Cost to Obtain First Tenant. This includes: – Advertising Costs – Legal Cost to Prepare Tenancy Agreement – Stamp Duty – Commission to Real Estate Negotiator |
In Adam’s case, his monthly loan repayments are RM 10,000 a month. Thus, only the interest portion of his loan repayment is recognised as deductible expenses which can be offset from his rental income.
For instance, if Adam’s mortgage instalment can be broken down into RM 5,000 in interest expenses and RM 5,000 in capital repayments, he can offset as much as RM 5,000 in interest costs from his monthly rental income of RM 14,000.
If you want to know how to offset your losses from investment properties against business income this article gives you valuable information any property investor should know.
2. Tax on Rental Income Classification
Second, Adam’s rental income from his real estate portfolio can be taxed either under Section 4(a) Business Income or under Section 4(d) Rental Income. There are a number of differences in their tax treatments. They are as follows:
| Tax Rules | Section 4(a) Business Income | Section 4(d) Rental Income |
|---|---|---|
| Furniture and Fittings | Capital Allowances are Claimable | Deductible on Cost Replacement Basis |
| Rental Loss | Can be Used to Deduct Personal Income Tax or to be Carried Forward and be Absorbed in the Following Year | Treated as Permanent Loss In the Current Year |
Thus, the question is, ‘How should Adam determine his classification of income tax for rental income derived from his real estate portfolio?’
The answer lies in whether or not, Adam is providing maintenance and support services actively and comprehensively to his properties either by Adam himself or through his engagement of others to do it on behalf of him.
For instance, two of Adam’s properties may be as follows:
a. Property 1: Commercial SOHO
Adam hires a property management solutions company to actively and comprehensively manage a SOHO unit regularly. Out of which, Adam is receiving a monthly rental income of RM 2,500. Hence, Adam’s RM 2,500 in income is taxed under Section 4(a) Business Income.
b. Property 2: Three-Storey Shop House
Adam has a three-storey where he collects RM 7,000 in rental income a month from four long-term tenants. Currently, he does not provide any support and maintenance services to his tenants. As such, his RM 7,000 in monthly income is taxed under Section 4(d) Rental Income.
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3. Capital Allowances
From above, we mentioned briefly about capital allowances, where they can be claimed by Adam if his rental income is taxed as a business income. It is of great help to Adam if he has undertaken any refurbishment works to further enhance the value of his properties in Malaysia.
Let us assume Adam has spent RM 15,000 to refurbish one of his property in Malaysia with the following expenditures:
a. RM 2,000 to install a Brand New Air-Conditioner
b. RM 2,000 to replace an old Air-Conditioner with a Brand New One.
c. RM 11,000 to replace damaged tiles and pipes.
So, how should Adam treat the above expenses?
It depends on whether or not, Adam’s tax on rental income from this property in Malaysia is under Section 4(a) Business Income or Section 4(d) Rental Income because they would be treated differently. Their tax treatments are as follows:
| Expenditures | Section 4(a) Business Income | Section 4(d) Rental Income |
|---|---|---|
| Installation of Brand New Air-Conditioner (RM 2,000) | Capital Allowance Claimable | Not Deductible (Capital Expenditures) |
| Replacement of One Old Air-Conditioner (RM 2,000) | Deductible in Full | Deductible in Full (Cost Replacement Basis) |
| Replacement of Damaged Tiles and Pipes (RM 11,000) | Deductible in Full | Deductible in Full |
| Final Tax Treatment: Deductible Expenses: Capital Allowance: | – RM 13 000 RM 2 000 | – RM 13 000 n/a |
4. Qualification for 50% Income Tax Deduction
Fourth, Adam is able to claim 50% exemptions on the tax on rental income if he:
a. Rents out his residential properties at a rate below RM 2,000 a month.
b. The exemption is applicable for each property if Adam has in excess of one property in this category.
c. Applicable for Year Assessment (YA) 2018 to 2020.
For instance, let us assume that Adam has the following properties:
a. Property 1: Commercial SOHO – Rental Income: RM 2,500 a month
b. Property 2: 3-Storey Shop House – Rental Income: RM 7,000 a month
c. Property 3: MVP Condominium – Rental Income: RM 3,100 a month.
d. Property 4: Alam Apartment – Rental Income: RM 900 a month
e. Property 5: A+ Serviced Apartment – Rental Income: RM 1,500 a month
Which of Adam’s properties qualify for the 50% income tax exemptions?
A+ Serviced AppartmnetRM 1 500 Commercial No (Commercial)
| Property | Monthly Rent | Property Title | Tax Exemptions |
|---|---|---|---|
| Commercial SOHO | RM 2 500 | Commercial | No (Commercial) |
| 3-Storey shop House | RM 7 000 | Commercial | No (Commercial) |
| MVP Condominimum | RM 3 100 | Resident | No (> RM 2 000) |
| Alam Appartmet | RM 900 | Resident | Yes |
5. Income Status
Does Adam have other sources of income? This would greatly affect how much tax on rental income he should pay
Scenario 1:
For instance, Adam could still be employed and earns a monthly income of RM 20,000 from his employer or his business. Let us assume Adam earns himself a net rental income of RM 5,000 a month after deduction of allowable expenses, his total monthly income would be RM 25,000 a month or RM 300,000 a year.
Chances are, the portion of Adam’s tax on his rental income would be 24% or 24.5% if he chooses his income to be taxed individually and he has little personal reliefs on his income tax.
It may have cost Adam more income tax payments, which is a disadvantage if:
a. Adam is an elderly man (above 50 years old)
b. Adam wishes to par down his debt levels.
But, on the flip side, it is an advantage to Adam if he wishes to invest and add one more property in Malaysia to his portfolio. It is because the more income he declares to the Inland Revenue Board (IRB), the higher the loan amount he may obtain from his local banker.
Hence, if Adam plans to lower his tax on rental income payments, he may opt to register a company to:
a. Incorporate his business into a Private Limited entity (Sdn Bhd). Hence, his business income would be subjected to a maximum tax rate of 17%, which is lower than 24% or 24.5% stated above.
b. Incorporate Sdn Bhd for the sole purpose to hold his real estate assets. Apart from lowering tax payments, holding real estate via corporations is an efficient way of distributing wealth to Adam’s loved ones if he has a wife and many children.
Scenario 2:
In contrast, Adam could have a stake in a loss-making business. For instance, he may be a retiree and is supporting his children in their business ventures. Let us assume Adam is given a 20% interest in the business and is a sleeping partner of the venture.
The business has incurred a loss of RM 100,000 in a financial year. Hence, Adam can use his business loss of RM 20,000 to offset his monthly rental income and thus, reduces his tax on rental income payments in that financial year.
Conclusion:
In essence, real estate investing is a team sport. If you have noticed, it involves a combination of intelligence from different areas which include corporate law, banking, and tax planning. For most, an astute real estate investor would have a team that comprises of tax planners and legal advisors apart from his bankers and agents. Thus, it would be great to have a team to help you too if you desire to boost your chances to become a successful property investor.
If so, you may use Joolah.my, a free search tool that connects you to the best accounting, tax agents and bookkeeping services providers in Malaysia in a matter of minutes.
