Expenses that landlords can deduct

Landlords must pay tax on any profit from their property rental business (although income from property of less than £1,000 a year can be ignored). In working out the profits, expenses are deducted from rental income. To ensure that the landlord does not pay more tax than is necessary, it is important to deduct all allowable expenses. Remember, the profit calculation is undertaken for the property income business as a whole, not on a property by property basis. Consequently, it does not matter whether the expenses incurred in relation to an individual property exceed the rental income from that property – it is the overall result that matters.

Cash basis

From 6 April 2017, the cash basis is the default basis for eligible landlords. Where accounts are prepared on the cash basis, it is the date that the expenditure was incurred that is the key date.

Allowable expenses

An expense is an allowable expense if it is incurred wholly and exclusively for the purposes of renting out the property.

Common examples of expenses which may be allowable include:

  • repairs and maintenance
  • water rates
  • council tax
  • gas and electricity
  • insurance (e.g. landlords’ buildings and contents insurance)
  • gardening costs
  • cleaning costs
  • letting agents’ fees
  • accountants’ fees
  • rents where the property is sub-let
  • office expenses, such as phone calls, stationery, etc.
  • cost of advertising for new tenants

Interest and other finance costs

Relief is available for interest on a loan up to the value of the property when it was first let. However, the way in which relief is given for interest is changing from relief as a deduction from income to relief as a deduction at the basic rate from the tax that is due.

For 2017/18, relief for 75% of the interest costs is available as a deduction and relief for the remaining 25% as a basic rate tax reduction, for 2018/19, relief for 50% of the interest costs is available as a deduction, with relief for the remaining 50% as a basic rate tax reduction. For 2019/20, only 25% of the interest costs are deductible, with relief for the remaining 75% being given as a basic rate tax reduction. From 2020/21 onwards, relief for all interest costs is given as a basic rate tax reduction.

Vehicles

A deduction for vehicle costs can, from 6 April 2017 onwards, be claimed using the approved mileage rates. This is generally easier than working out the deduction based on actual costs (although this method can be used if preferred). The rates are as follows:

Vehicle Rate
Cars and vans 45p per mile for first 10,000 business miles in the tax year 25p per mile for subsequent miles
Motorcycles 24p per mile

Capital expenditure under the cash basis

Under the cash basis, expenditure for capital items is deductible unless specifically disallowed. Capital items for which a deduction is not allowed include land and cars.

Domestic items

Where the property is let furnished, a deduction is allowed for replacement domestic items, as long as they are of an equivalent standard to the item being replaced. A deduction is not allowed for enhancement expenditure.

Property allowance A property allowance of £1,000 is available. Property income of less than £1,000 does not need to be reported to HMRC. Where income exceeds £1,000, the £1,000 allowance can be deducted instead of deducting actual expenses. This will be beneficial where actual expenses are less than £1,000.

Year-end tax planning tips

As the end of the 2018/19 tax year approaches, it is worthwhile taking time for some last-minute tax planning. Here are some simple tips that may save you money.

  1. Preserve your personal allowance: the personal allowance is reduced by £1 for every £2 by which income exceeds £100,000. For 2018/19, the personal tax allowance is £11,850, meaning that it is lost entirely once income exceeds £123,700. Where income falls between £100,000 and £123,700, the effect of the taper means that the marginal rate of tax is a whopping 60%. Where income is over £100,000, consider making pension contributions or charitable donations to reduce income and preserve the personal allowance. Where this is an option, consider also deferring income until after 6 April 2019 to reduce 2018/19 income.
  2. Claim the marriage allowance: the marriage allowance can save a couple tax of £238 in 2018/19. Where an individual is unable to utilise their personal allowance, they can make use of the marriage allowance to transfer 10% of their personal allowance (rounded up to the nearest £10) to their spouse or civil partner, as long as neither pay tax at the higher or additional rate. The marriage allowance must be claimed.
  3. Pay dividends to use up the dividend allowance: family and personal companies with sufficient retained profits should consider paying dividends to shareholders who have not yet used up their dividend allowance for 2018/19. The dividend allowance is set at £2,000 and is available to all individuals, regardless of the rate at which they pay tax. The use of an alphabet share structure enables individuals to tailor dividend payments according to the individual’s circumstances.
  4. Make pension contributions: tax relieved pension contributions can be made up to 100% of earnings, capped at the level of the annual allowance. The annual allowance is set at £40,000 for 2018/19 (subject to the reduction for high earners). Where the annual allowance is not used up in year, it can be carried forward for up to three years.
  5. Transfer income-earning assets to a spouse or civil partner: where one spouse or civil partner has unused personal allowances or has not fully utilised their basic rate band, considering transferring income earning assets into their name to reduce the combined tax liability (but non-tax considerations such as loss of ownership should be taken into account).
  6. Put assets in joint name prior to sale: spouses and civil partners can transfer assets between them at a value that gives rise to neither a gain nor a loss. This can be useful prior to selling an asset which will realise a gain in order to take advantage of both partners’ annual exempt amount for capital gains tax purposes.
  7. Make gifts for inheritance tax purposes: individuals have an annual exemption for inheritance tax of £3,000, allowing them to make gifts free of inheritance tax each year. Where the allowance is not used, it can be carried forward to the next year, but is then lost.

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Would you rent out a property as a long-term rental or holiday let?

Where a property is located in a holiday region, a consideration will be whether to let it as a holiday let or on a longer-term basis. As well as differing rental income profiles, there are tax differences to consider.

Furnished holiday lets

From a tax perspective, special rules apply to furnished holiday lets, which provide a number of advantages compared to the tax regime applying to other rental business.

Furnished holiday lettings:

  • benefit from capital gains tax reliefs for traders such as business asset rollover relief, entrepreneurs’ relief, relief for gifts of business assets and relief for loans to traders;
  • benefit from availability of plant and machinery capital allowances for items of furniture, fixtures and fittings; and
  • profits count as earnings for pension purposes.

To benefit from these advantages, any furnished holiday lettings are treated separately from other lets and the profits must be worked out separately for each furnished holiday lettings business.

What counts as a furnished holiday let

The property must be in the UK or the EEA and must be let furnished; the furniture provided must be sufficient for normal occupation and visitors must be able to use the furniture. The property must also be commercially let.

UK and EEA lets are treated as different furnished holiday lettings businesses.

The furnished holiday letting must also pass various tests.

The occupancy tests

There are three occupancy tests and all must be met for the property to be treated as a furnished holiday letting for tax purposes.

The pattern of occupation condition

A let will not count as a furnished holiday letting if the total of all lettings that exceed 31 days is more than 155 days in the tax year.

The availability condition

The property must be available for letting as a furnished holiday accommodation for at least 210 days in the tax year.

The letting condition

The property must be commercially let as furnished holiday accommodation for at least 105 days in the tax year. Longer lets of more than 31 days are excluded, unless the let extends beyond 31 days due to unforeseen circumstances.

If the property fails the letting condition and is not let for 105 days in the tax year, there are two concessionary routes by which the property may still qualify – by making an averaging election or a period of grace election. The elections can be used together.

Averaging election

Where a landlord has more than one property which is let as furnished holiday accommodation, the condition is treated as met where an averaging election is made as long as on average each property is let for at least 105 days in the tax year. So, for example, if a landlord has 4 properties which in total were let on lets of less than 31 days for at least 420 days, the letting conditions is met under an averaging election, even if any individual property is let for less than 105 days.

An averaging election must be made by the anniversary of 31 January following the end of the tax year, i.e. by 31 January 2021 for 2018/19.

Period of grace election

The second way in which the condition can be treated as met is by making a period of grace election where it can be shown that there was a genuine intention to let the property, but this did not happen due to unforeseen circumstances. The letting condition must have been met in the year before that for which the first period of grace election is made. A second period of grace election is permitted, but if a property does not meet the letting threshold in the fourth year after two consecutive period of grace elections, it will no longer qualify as a furnished holiday letting.

Losses

Losses can now only be carried forward and set against profits from the same furnished holiday lets business.

If the property does not qualify as a furnished holiday let, the normal tax rules for rental businesses apply.

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Rent-a-room: Can you benefit?

Rent-a-room relief was introduced to encourage people to let spare rooms in their own home in order to increase the supply of low-cost rental accommodation. In return, the recipient is able to earn up to £7,500 a year tax-free.

Plans to restrict the relief so that it was only available where the occupation by the tenant overlapped with that of the landlord for at least one night have been abandoned – meaning that it is still possible to benefit from the relief for Airbnb-type lets where the property may be rented out for a short time in the landlord’s absence. It can also be used by those running a bed-and-breakfast.

Qualifying accommodation

To qualify the accommodation must be let furnished in the landlord’s home – it does not matter whether the home is owned or rented (but where rented, check that sub-letting is permitted). Where more than one person benefits from the income, the tax-free limit is halved, regardless of how many people share the income.

The relief

Rental income up to the rent-a-room limit is tax-free and does not need to be reported to HMRC. Where the rental income is more, the landlord has a choice:

  • work out rental profit in the usual way by deducting expenses from the rental income;
  • deduct the rent-a-room limit from the rental income and pay tax on the difference.

Using the rent-a-room limit will be beneficial where this is more than actual expenses. Where this route is taken, the relief should be claimed on the self-assessment tax return by ticking the appropriate box.

Case study 1

John is single and has a two-bedroom house. He lets out his spare room for £400 a month. He qualifies for rent-a-room relief. As his rental income of £4,800 is less than the rent-a-room limit, he does not need to declare it to HMRC.

Case study 2

Rob and Fiona are keen hikers and go away each weekend in the summer. They let out their Brighton flat via Airbnb while they are away. In 2018/19 they earned rental income £6,000, which they shared equally.

Rob and Fiona share the income and each have a rent-a-room limit of £3,750. As the rental income from letting out the flat (£3,000 each) is less than their rent-a-room limit, they are eligible for rent-a-room relief and do not need to report the income to HMRC.

Case study 3

Julie runs a B and B in Cheltenham. In 2018/19, she receives rental income of £12,000. Her expenses are £3,000.

As her rental income is more than £7,500 she must report it to HMRC. However, she can still benefit from rent-a-room relief by opting to work out her profit by deducting the rent-a-room limit of £7,500 rather than actual costs of £3,000. Thus, her taxable profit is only £4,500, rather than £9,000 (which would be the profit in the absence of rent-a-room relief). By claiming the relief, she will save tax of £900 if she is a basic rate taxpayer and tax of £1,800 if she is a higher rate taxpayer.

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Interest relief for renovation or development costs

Often, when a property is purchased there is work to be done before it can be let out or sold. Where this work is financed by a mortgage or other loan, the way in which and the extent to which relief is available for the interest costs depends whether it falls with the property income or trading income tax rules.

The following case studies illustrate the different approaches.

Case study 1: Buy-to-let investment

Simon buys a property as an investment, with the intention to let it out long term. The property has been neglected and needs doing up before he can put it on the rental market. The property costs £250,000 and Simon has budgeted £40,000 to renovate it. The purchase and refurbishment work are financed with savings of £70,000 and a mortgage of £220,000. Interest on the mortgage is £800 per month.

The purchase completes on 1 May 2018. The renovation work takes six months and the property is let from 1 November 2018. At the time the property is let, it is valued at £280,000.

Under the property income rules interest is allowed as a deduction or tax reduction (as appropriate) to the value of the property when first let. In this case the value of the property when first let (£280,000) is more than the mortgage of £220,000, so relief for the full amount of the interest is allowed in computing the rental profit. For 2018/19, 50% of the interest costs are deductible from the rental income, with relief for the remaining 50% being given as a basic rate tax reduction. For 2019/20, 25% of the interest costs are eligible as a deduction, with relief for the remaining 75% being given as a basic rate tax reduction.

Relief for the interest incurred in the renovation period before the property was first let is available under the pre-commencement provisions. These allow relief to the extent that it would be available had the interest been incurred while the property was let. The interest in the pre-letting period (i.e. that relating to the period from 1 May 2018 to 31 October 2018 of £4,800) is treated as incurred on the day that the property rental business commences, i.e. 1 November 2018.

Case study 2

David also buys a property to do up. However, his intentions are different to Simon in that he wishes to do the property up as quickly as possible and sell at a profit, buying a further property to do up with the proceeds. David is a property developer rather than a landlord and any interest costs incurred in funding the development are deductible under the trading provisions in computing his trading profit. This would be the case regardless of whether David operates as a sole trader or other unincorporated business or forms a company through which to carry out his property development business. Availability of the interest deduction depends on the ‘wholly and exclusively’ rule being satisfied.

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Jointly-owned property – who pays the tax?

Where property is jointly-owned, the way in which the rental income can be split between the joint owners for tax purposes depends on whether the joint owners are married or in a civil partnership or not.

Married couples and civil partners

Where a property is jointly owned by a married couple or civil partners, the basic rule is that the rental income is split equally, regardless of the actual underlying ownership.

Example

Tom and Richard are married. They jointly own a flat in which Tom has a 70% stake and Richard has a 30% stake. The flat is let out. The rental profit is £8,000 a year.

Despite owning the property in unequal shares, Tom and Richard are both taxed on 50% of the rental income (£4,000).

However, where the beneficial ownership is unequal, the couple can elect (on Form 17) for the income to be assessed for tax purposes in accordance with their actual beneficial shares. In the above example, were Tom and Richard to make a Form 17 election, Tom would be taxed on rental profits of £5,600 (70%) and Richard would be taxed on £2,400 (30%).

For married couples and civil partners, the only permissible allocations are 50:50 (the default position) and, on the making of a Form 17 election, in accordance with actual ownership where the property is owned in unequal shares.

Joint owners who are not married or in a civil partnership

Where a property is owned jointly by individuals who are not married or in a civil partnership, it is usual for the rental income to be allocated in accordance with the ownership share. However, the joint owners can agree to a different division of profits and losses – the allocation for tax purposes does not have to mirror the actual ownership of the property. However, where a different allocation is agreed, the split for tax purposes must match the actual allocation of rental profits.

Example

Jake and his girlfriend Jade jointly own a flat which they let out. Jake owns 20% of the property and Jade owns 80% of the property. The rental profit is £10,000 a year.

Jade has £3,000 of her basic rate band available, whereas Jake has £9,000 of his basic rate band available. Therefore, to minimise the tax payable on the rental income, they agree that it will be shared so that Jade receives 30% (£3,000) and Jake receives 70% (£7,000).

Where joint owners are not married or in a civil partnership it is possible to agree an actual allocation that minimises tax. However, depending on the relationship between the owners, the tax considerations may be secondary as each owner may be keen to receive a share of rental profits proportionate to their actual stake in the property.

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