It is easy to fall into the trap of assuming that legal and professional costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however this is only part of the story.  

Legal and professional fees – Capital or revenue?

At some point, a landlord is likely to incur legal and professional fees in connection with the running of their property rental business. It is easy to fall into the trap of assuming that these costs can be computed in calculating taxable profits if they are incurred wholly and exclusively for the purposes of the business; however this is only part of the story. The landlord must also determine whether the costs are revenue or capital in nature. The rules also differ depending upon whether the accounts are prepared on the cash basis or using traditional accounting under the accruals basis.

The rule

The nature of the legal fees follow that of the matter to which they relate – so if the fees are incurred in relation to an item which is itself revenue in nature, the legal and professional fees are also revenue in nature. Likewise, legal fees that are incurred in connection with a matter that is capital in nature are also capital in nature.
Legal fees that are revenue in nature would include, for example, fees incurred to recover unpaid rent, while legal fees that are capital in nature would include fees incurred in connection with the purchase of a property.

Cash or accruals basis

Revenue items are deductible in computing profits regardless of whether they are prepared under the cash or accruals basis, although the time at which the relief is given will differ. Under the cash basis, the deduction is given for the period to which the expenditure relates, for the cash basis the deduction is given for the period for which the expenditure is incurred.
For capital expenditure different rules apply. No deduction is allowed for capital expenditure under the accrual basis, whereas under the cash basis, the treatment depends on the nature of the item – capital expenditure is deductible under the cash basis unless the expenditure is of a type for which a deduction is expressly forbidden. Items of the forbidden list include expenditure in or in connection with lease premiums and the provision, alteration or disposal of land (which includes property).

Example of allowable revenue items

A deduction for legal and professional fees will normally be allowed where they relate to:
• costs of obtaining a valuation
• normal accountancy costs incurred in preparing accounts of the rental business and agreeing the tax liabilities
• costs of arbitration to determine the rent
• the costs of evicting an unsatisfactory tenant to re-let the property

Example of capital expenses

The following are examples of legal and professional fees which are capital in nature:
• legal costs incurred in acquiring or adding to a property
• costs in connection with negotiations under the Town and Country Planning Act
• fees incurred in pursuing debts of a capital nature, such as the proceeds due on sale

Leases

Leases can be tricky. The expenses incurred in connection with the first letting or subletting for more than one year are deemed to be capital and therefore not deductible – this would include the legal fees incurred in drawing up the lease, surveyors’ fees and commission. However, if the lease is for less than one year, the associated expenses can be deducted. Normal legal and professional fees on the renewal of a lease are also deductible if the lease is for less than 50 years; although any proportion of the fees that relate to the payment of a premium are not deductible.
If a new lease closely follows the previous lease, a change of tenant will not render the associated fees non-deductible. However, if the property is put to other use between lets, or a long lease, say, replaces a short lease, the associated costs will be capital and non-deductible.

Partner note: HMRC’s Property Income Manual PIM 2120

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Renting out a property at a rate below the commercial level might sound like a great idea – but it might cost you dearly if you try to seek tax relief for your expenses!

Properties not let at a commercial rent

There may be a number of reasons why a property is occupied rent-free or let out at rent that is less than the commercial rate. This may often occur where the property is occupied by a family member in order to provide that person with a cheap home. For example, a parent may purchase a house in the town where their student son attends university and let it to the student, and maybe even his housemates, at a low rent to help them out. While the parents’ motives are doubtless philanthropic, their generosity may cost them dearly when it comes to obtaining relief for the associated expenses.

Wholly and exclusively rule

Expenses can only be deducted in computing taxable rental profits if they are incurred wholly and exclusively for the purposes of the property rental business. Unfortunately, HMRC take the view that unless the property is let at full market rent and the lease imposes normal conditions, it is unlikely that the expenses are incurred wholly and exclusively for business purposes. So, where the property is occupied rent-free, there is no tax-relief for expenses.

If the property is let at a rent that is below the market rent, a deduction is permitted, but this is capped at the level of the rent received from the let. This means that where a property is let at below market rent, it is not possible for a rental loss to arise, or for expenses in excess of the rent to be offset against the rent received from other properties in the same property rental business.
Periods between lets

Where there are brief periods where the property is occupied rent-free or let out cheaply, it may be possible to obtain full relief for expenses. For example, if the landlord is actively seeking a tenant and a relative house sits while it is empty, relief will not be restricted as long as the property remains genuinely available for letting. In their guidance HMRC state, that ‘ordinary house sitting by a relative for, say, a month in a period of three years or more will not normally lead to loss of relief’. However, if a relative takes a month’s holiday in a country cottage, relief for expenses incurred in that period will be lost.

Commercial and uncommercial lets

Where a property is let commercially some of the time and uncommercially at other times, expenses should be apportioned on a just and reasonable basis between the commercial and non-commercial lets. Any excess of expenses over rents in the period when commercially let can be deducted in the computing the profit for the rental business as a whole. However, an excess of expenses over rent when the property is let uncommercially are not eligible for relief.
Timing must also be considered – expenses relating to uncommercial lets cannot be deducted simply because they are incurred when the property is let commercially.

Partner note: HMRC Property Income Manual PIM 2130.

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This blog explains what qualifies for relief for finance costs, the limit on eligible borrowings, and how capital repayments work with a quick example.

Allowable finance costs

Although the way in which landlords obtain relief for finance costs on residential properties is changing, there is no change to the type finance costs that are eligible for relief.

What qualifies for relief

The basic rule is that relief is available for expenses that are incurred wholly or exclusively for the purposes of the property rental business, and this rule applies equally to finance costs. Relief is available for eligible finance costs where they meet this test.

The definition of finance costs includes mortgage interest and interest on loans to buy furnishing and suchlike. Relief is also available for the incidental costs of obtaining finance, as long as the interest on the loan is allowable. Incidental costs of loan finance include items such as arrangement fees, and fees incurred when taking out or repaying loans or mortgages.

Limit on eligible borrowings

A landlord can obtain relief for the costs of borrowings on a loan or mortgage up to the value of the property when it was first let. Buy-to-let mortgages are often more expensive than residential mortgages with interest charged at a higher rate. The loan does not have to be secured on the let property. Where a landlord wishes to buy a rental property and has sufficient equity in their own home, it may make commercial sense to release capital from the home by borrowing against it and using the money to purchase the rental property. Interest on the loan is eligible for relief, despite the fact the loan is not secured on the rental property.

No relief for capital repayments

Capital repayments, such as the capital element of a repayment mortgage or loan repayments, are not eligible for relief. Where the borrowings are in the form of a repayment mortgage, it will be necessary to split the payment between the interest and capital when working out the relief. The lender should provide this information on the statement.

Example

Mervyn wishes to invest in a buy to let property. As he only has a small mortgage on his home, he remortgages to release £150,000 of equity.
Following the remortgage, he has a mortgage of £200,000 on his own home. Using the released equity, he buys a property to let for £150,000. He spends some time renovating the property in his spare time before letting it out. When the property is first let, it has a value of £160,000.

During the 2019/20 tax year, Mervyn pays mortgage interest of 10,000and makes capital repayments of £10,800. The property is let throughout.
Mervyn can claim relief for 80% of the interest costs – this is attributable to the borrowings of £160,000 (80% of the loan of £200,000), being the value of the let property when first let. The interest eligible for relief is therefore £8,000 (80% of £10,000). For 2019/20, 25% (£2,000) is relieved by deduction with the balance giving rise to a deduction from the tax due of £1,200 (75% x £8,000 x 20%).

No relief is available for the capital repayments.

Partner note: ITTOIA 2005, ss. 272A, 272B, 274A, 274B

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In essence, it’s all about the ‘wholly and exclusively’ test – could it be time to invest in some branded sweatshirts?

Dual purpose expenditure – can landlords claim a deduction?

Landlords are able to claim tax relief for expenses that are incurred wholly and exclusively for the purposes of the property rental business. However, some expenses have both a private and a business element. Where this is the case, is any relief available?

Business element separately identifiable

If it is possible to separate the business and the private expenditure, a deduction can be claimed for the business element. This may be the case, for example, in relation to a car which is used for both private journeys and for the purposes of the property rental business, to visit tenants or to check on the properties. Likewise, a landlord may use his or her mobile phone for private calls and also for business calls. From the call log, it will be possible to identify the business calls and to apportion the bill between business and private calls.

Business element cannot be separately identified

If the expenditure is dual purpose in nature and it is not possible to identify the business element, no deduction is allowed. The expenditure does not meet the ‘wholly and exclusively’ test, and as such is not deductible in computing the profits of the property rental business. An example of expenditure that may fall into this category is clothing, even if only worn for working in the property rental business. The clothing fails the wholly and exclusively test as it also provides the landlord with warmth and decency (a private purpose). However, it should be noted that a deduction is allowed for clothing that bears a conspicuous advert for the business, such as a sweatshirt featuring the name of the property rental business and the logo.

Example

Dave is a landlord and has a number of properties that he rents out to students. He uses the same car for the purposes of the property rental business as for private journeys.

Dave undertakes the decorating and much of the maintenance on the properties himself. He has purchased overalls specifically for this purpose, which he wears only when undertaking work on the let properties. In the tax year, he spends £80 on overalls.

In the tax year in question, Dave drove 6,800 miles of which 4,200 were for the purposes of his property rental business.

A deduction is allowed for the business mileage. Dave uses the simplified mileage system, claiming a deduction of £1,890 (4,200 miles @ 45p per mile).

However, although he only wears the overalls when working on his let properties, the private benefit cannot be distinguished from the business use. Consequently, the ‘wholly and exclusively’ test is not met, and the £80 which Dave spent on overalls cannot be deducted in computing the taxable profit for his property rental business.

Partner note: ITTOIA 2005, s, 34.

 

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In this blog we set out the three conditions property must meet to be considered a furnished holiday let and to access all the advantages they bring, and top tip – letting to family or friends at a reduced rate doesn’t count! 

Many Airbnb lets are used as holiday accommodation. From a tax perspective, furnished holiday lettings enjoy some tax advantages over other lets. So, is it possible for an Airbnb let to benefit from these advantages and what conditions must be met?

Qualifying conditions

Simply letting a property as furnished holiday accommodation is not in itself sufficient to qualify for the furnished holiday letting (FHL) treatment. As with other lets, Airbnb lets must meet the conditions set out in the legislation.

The first point to note is that the FHL treatment is only available to properties which are in the UK or the EEA and which are let furnished.

Occupancy conditions

There are three occupancy conditions which must be met for a property to be treated as FHL.

Condition 1 – the pattern of occupancy condition

The pattern of occupancy condition is met if the total of all lettings in the tax year exceeding 31 days is 155 days or less. The nature of holiday letting is multiple short lets rather than longer lets and this condition seeks to recognise this.

Condition 2 – the availability condition

To meet this condition the accommodation must be available for letting for at least 210 days in the tax year. Days where the owner stays in the property do not count as days when the property is available for letting.

Condition 3 – the letting condition

The letting condition is met if the property is let commercially as furnished accommodation to the public for at least 105 days in the tax year. Only commercial lets count towards this total – any days when the property is let to family or friends at a reduced rate or where they are allowed to use the property for free are ignored.

Longer term lets of more than 31 days are also ignored (unless a let which was supposed to be less than 31 days is extended due to unforeseen circumstances, such as a delayed flight or the holidaymaker becoming ill).

Averaging election

If a person has more than one property let as holiday accommodation (whether via Airbnb or similar or otherwise), an averaging election can be made where the letting condition of 105 days is not met. As long as the average let across all properties is at least 105 days in the tax year, the condition is treated as met. Thus, if a person has three holiday properties which were let commercially for periods of 31 days or less for at least 315 (3 x 105) days in the year, the average let would pass the test.

Period of grace election

A second election, a period of grace election, can be made if the landlord genuinely intended to meet the letting condition but was unable to do so, as long as the condition was met in the previous tax year. This will allow the property to continue to be treated as a FHL. If the condition is not met the following year, a second period of grace election can be made. However, if the condition is not met in the fourth year after two consecutive period of grace elections, the property will no longer qualify as a FHL.

Advantages

Qualifying as a FHL offers a number of advantages. It opens the door to various capital gains tax reliefs for traders, including entrepreneurs’ relief. The landlord is also eligible to claim plant and machinery capital allowances if the cash basis is not used. Profits also count as earnings for pension purposes.

Partner note: ITTOIA 2005, Pt. 3, CH. 6 ss. 322 – 328B).

 

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Property Tax

Landlords – you must file your self-assessment tax return by 31 January 2020 to avoid a late filing penalty. Here’s what you need to know:

The self-assessment deadline is looming. Self-assessment tax returns for the year to 5 April 2019 must be filed online by 31 January 2020 if a late filing penalty is to be avoided.

Landlords will need to complete the property income pages. Particular care should be taken where the landlord has a loan or a mortgage as the way in which relief is given for financing costs is changing and the position for 2018/19 is different to that for 2017/18.

The way in which relief for finance costs is given is moving from relief by deducting the finance costs when computing profits to giving relief in the form of a basic rate tax reduction. The 2018/19 tax year is a transitional year.

What costs are eligible for relief?

Interest payable on loans to buy land or property which is used in the rental business is eligible for relief, as is interest on loans to fund improvements or repairs. It should be noted that it is not necessary for the loan to be secured on the let property – the rule is that interest is allowable on borrowings up to the value of the property when first let. Thus, if a landlord borrowed against their main home to fund a buy-to-let investment property, the interest on that loan would be allowable on the loan up to the value when the property was first let. If the mortgage on the residential property is more, the allowable interest is proportionately reduced.

Relief is also available for the costs of getting a loan.

It should be noted that it is only the interest and other finance costs which qualifies for relief – no relief is available for any capital repayments which may be made.

The position for 2018/19

For 2018/19, relief for 50% of eligible finance costs is given as a deduction in computing the profits of the property rental business and relief for the remaining 50% is given as a basic rate tax reduction. This makes completing the property pages of the tax return slightly tricky as the information must go in two places.

The first box which needs to be completed is Box 26. This is where allowable loan interest and other financial costs need to be entered. Amounts entered in this box are deducted in computing rental profits. Therefore, as only 50% of the allowable finance costs for 2018/19 are relieved in this way, only 50% of the costs for that year should be entered in this box.

The remaining 50% is entered in Box 44, helpfully titled ‘Residential finance costs not included in box 26’. The amount entered in this box is used to calculate a reduction in the landlord’s tax bill. The reduction is equal to 20% (the basic rate of income tax) of the amount entered in Box 44.

If you have any unrelieved finance costs from earlier years, these should be entered in Box 45. Any balance of residential finance costs which is unrelieved may be carried forward to future years for relief by the same property business.

Partner note: Self-assessment UK Property notes (SA105); see www.gov.uk/government/publications/self-assessment-uk-property-sa105.

 

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It can pay off to keep track of your business mileage you incur for your rental properties – here’s why.

Using your car in your property rental business

Landlords will often use their car for the purposes of their property rental business. Where they do so, they are able to claim a deduction for the costs that they incur.

Using mileage rates

Where a landlord uses their car for business purposes, the easiest way to work out the amount that can be deducted is to make use of the simplified expenses system and use the relevant mileage rates to claim a deduction based on the business mileage undertaken.

For cars (and also vans) the rate is set at 45p per mile for the first 10,000 business miles in the tax year and at 25p per mile for any subsequent business mileage.

Example

Karen is an unincorporated landlord and has three properties that she lets out. During the tax year, she undertakes 712 business miles in her own car in respect of her property business.

She claims a deduction of 45p per mile, a total deduction for the year of £320.40.

Deduction based on actual costs

The use of simplified expenses, while generally easier from an administration perspective, is not compulsory. The landlord can instead claim a deduction based on the actual costs. However, in practice this will be time consuming. Further, where the car is used for both business and private travel, a deduction is only permitted for the business element. Separating actual costs between business and private travel can be very time consuming and will only be worthwhile where it gives rise to a significantly higher deduction than that obtained by using the mileage rates.

Capital allowances

Capital allowances cannot be claimed where mileage allowances are claimed. Where a deduction is based on actual costs, capital allowances can be claimed in respect of the car. However, the claim must be adjusted to reflect any private use. So, for example, if a car is used for the purposes of the property business 20% of the time and for private use 80% of the claim, any capital allowance claim must be restricted to 20%.

Other travel

The costs of travel on public transport or by taxi can be deducted in computing the profits of the property rental business to the extent that it constitutes business travel for the purposes of that business.

Partner note: ITTOIA 2005, s. 94D

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The delayed start date for the domestic reverse VAT charge has given businesses an extra year to prepare for the charge. We explain what you can do to prepare.

Domestic reverse VAT charge for building and construction services

The domestic reverse VAT charge for building and construction services was due to come into effect from 1 October 2019. However, in early September it was announced that the start date had been put back one year. As a result, the charge will now apply from 1 October 2020.

Who is affected?

The charge will affect individuals and businesses who are registered for VAT in the UK and who supply or receive specified services that are reported under the Construction Industry Scheme (CIS).

Nature of a reverse charge

The reverse charge means that the customer receiving the specified supply has to pay the VAT rather than the supplier. In turn, the customer can recover the VAT under the normal VAT recovery rules.

Supplies within the scope of the charge

The reverse charge will apply to supplies of building and construction services which are supplied at the standard or reduced rates that also need to be reported under the CIS. These are called specified supplies.

However, where materials are included within a service, the reverse charge applies to the whole amount. By contrast, where deductions are made from payments to subcontractors under the CIS, no deductions are made from any part of the payment that relates to material.

Move to monthly returns

The introduction of the reverse charge will mean that some businesses may become repayment traders claiming VAT back from HMRC rather than paying it over to HMRC. To aid cashflow and reduce the delay in claiming the VAT back, repayment traders can move to monthly returns.

Planning ahead

The delayed start date has given businesses an extra year to prepare for the charge. In order to be ready for its introduction, businesses within the CIS should:

  • check whether the reverse charge will affect their sales, their purchases or both
  • update their accounting systems and software to deal with the reverse charge from 1 October 2020
  • consider whether the change will impact on cashflow
  • ensure that staff who are responsible for VAT accounting are familiar with the reverse charge and how it will operate

Contractors should review their contracts with subcontractors to determine whether the reverse charge will apply to services received under the contract. Where it does, they will need to notify their suppliers.

Subcontractors will need to contact their customers to obtain confirmation from them as to whether the reverse charge will apply, and also whether the customer is an end user or intermediary supplier.

Impact of change of start date

HMRC recognise that the start date was changed at short notice and that businesses may have changed their invoices to meet the needs of the reverse charge and cannot easily change them back. Where errors arise as a result, HMRC will take the change of date into account.

Partner Note: The Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) Order 2019 (SI 2019/892); The Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) (Change of Commencement Day) Order 2019 (Si 2019/1240).

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If you’ve read anything about property and tax, you’ll probably have heard the terms ‘nominating your main residence’ and ‘flipping’. This blog takes you exactly what these terms mean and how and when they apply.

Private residence relief shelters a gain on the sale of a residence from capital gains tax while the property has been the owner’s only or main residence. Where a property has been an only or main residence at some point, the final period of ownership (currently 18 months but reducing to nine months from 6 April 2020) is also exempt from capital gains tax.

Only one main residence at a time

As the name suggests, the relief is only available in respect of the only or main residence. Thus, where a person has more than one home, only one of those homes can be the ‘main residence’ at any given time.

However, as long as certain conditions are met, the taxpayer is free to choose which property is classed as the ‘main’ residence for capital gains tax purposes – it does not have to be the one in which the owner spends the majority of his or her time.

Only one main residence per couple

A couple who are married or in a civil partnership and who are not separated can only have one main residence between them.

Property must be a residence

Only properties that are lived in as a home can be a ‘main residence’ – a property which is let out can’t be a main residence while it is let.

Making an election

Where a person has only one residence, that residence is their only or main residence. Where they acquire a second residence, they have a period of two years to nominate which residence is the main residence for capital gains tax purposes. Where residences are acquired or sold, the clock starts again from the date on which the particular combination of residences changes, and the taxpayer then has another two years in which to elect which residence is the main residence.

The election should be made in writing to HMRC. The letter should include the full address of the property being nominated as the main residence and should be signed by all owners of the property.

No election made

In the absence of an election, the property which is the main residence will be determined as a question of fact and will be the property in which the person lives in as their main home. For example, if a couple has a family home and a holiday home, in the absence of an election, the family home will be treated as the main residence.

Advantages of flipping

There are a number of advantages to a property being the main residence at some point in the period of ownership as not only is any gain while the property is the only or main residence exempt from capital gains tax; the final period of ownership is also exempt. Where the property is let, occupying the property as a main residence at some point may open up the option of lettings relief (although it should be noted that the availability of lettings relief is to be seriously curtailed from April 2020).

Once an election has been made to nominate a property as a main residence, this can be varied any number of times (‘flipping’). This can be very useful from a tax planning perspective, for example, occupying a property as a main residence after it has been let but before it is sold can shelter some of the gain. Flipping properties and making use of the capital gains tax annual exempt amount to shelter any gain that falls into charge when the property is not the main residence can be beneficial in reducing the tax bill.

Partner note: TCGA 1992, s. 222

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Do you have a second home? You might want to sell up before April 2020!

Private residence relief and the final period exemption

From a capital gains tax perspective, there are significant tax savings to be had if a property has been the owner’s only or main residence. The main gains are where the property has been the only or main residence throughout the whole period of ownership as private residence relief applies in full to shelter any gain arising on the disposal of the property from capital gains tax.

However, there are also advantages if a property enjoys only or main residence status for part of the ownership period; not only are any gains relating to that period sheltered from capital gains tax, but those covered by the final period exemption are also tax-free.

The final period exemption works to shelter any gain arising in the final period of ownership from capital gains tax if the property has at any time, however briefly, been the owner’s only or main residence. This can be particularly useful if the property is, say, lived in as a main home and then let out prior to being sold, or where a person has two or more residences.

Prior to 6 April 2020, the final period exemption applies generally to the last 18 months of ownership. Where the person making the disposal is a disabled person or a long-term resident in a care home, the final period exemption applies to the last 36 months of ownership.

From 6 April 2020, the final period exemption is reduced to nine months, although it will remain at 36 months for care home residents and disabled persons.

Planning ahead

Where a property which has been occupied as a main residence at some point, it could be very advantageous to dispose of it prior to 6 April 2020 rather than after that date to benefit from the longer final period exemption.

Example

Frankie has a cottage on the coast that he brought on 1 January 2010 for £200,000. He lived in it as his main residence for two years until 31 December 2011, when he purchased a city flat which has been his main residence since that date. He continues to use the cottage as a holiday home.

He plans to sell the cottage and expects to get £320,000.

Scenario 1 – sale on 31 March 2020

If Frankie sells the cottage on 31 March 2020, he will have owned the cottage for a total of 10 years and three months (123 months). Of that period, he lived in it for 24 months as his only or main residence. As the sale takes place prior to 6 April 2020, he will benefit from the final period exemption for the last 18 months.

The gain on sale is £120,000 (£320,000 – £200,000)

He qualifies for 42 months’ private residence relief, which is worth £40,976 (42/123 x £120,000).

The chargeable gain is therefore £79,024 (£120,000 – £40,976).

Scenario 2 – sale on 30 April 2020

If Frankie does not sell the property until 30 April 2020, he will only benefit from a nine-month final period exemption. If he sells on this date, he will have owned the property for 124 months. Assuming the sale price remains at £320,000 and the gain at £120,000, the gain which is sheltered by private residence relief is £31,935 (33/124 x £120,000), and the chargeable gain is increased to £88,065 (£120,000 – £31,935).

If planning to dispose of a property which has been an only or main residence for some but not all of the period of ownership, selling prior to 6 April 2020 will enable the owner to shelter the gain pertaining to the last 18 months of ownership.

Partner note: TCGA 1992, s. 223; Draft legislation for inclusion in Finance Bill 2019—20 (see Changes to ancillary reliefs in Capital Gains Tax Private Residence Relief – Draft Legislation).

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