Failing to take your record keeping obligations seriously as a landlord could mean that you pay more tax than necessary, or worse that you could be on the receiving end of a penalty from HMRC.

Buying a property to let – the importance of keeping records from day one

For tax purposes, good record keeping is essential. Without complete and accurate records, it will not be possible to provide correct details of taxable income or to benefit from allowable deductions. Aside from the risk of paying more tax than is necessary, landlords who fail to take their record keeping obligations seriously may also find that they are on the receiving end of a penalty from HMRC.

Recording expenses

A deduction is available for expenses that are incurred wholly and exclusively for the purposes of the rental business. A deduction is available for qualifying revenue expenses regardless of whether the accounts are prepared on the cash basis or under the traditional accruals basis.

Revenue expenses are varied and are those expenses incurred in the day to day running of the property rental business. They include:

  • office expenses
  • phone calls
  • cost of advertising for tenants
  • fees paid to a managing agent
  • cleaning costs
  • insurance
  • general maintenance and repairs

A record should be kept of all revenue expenses, supported by invoices, receipts and suchlike.

The treatment of capital expenditure depends on whether the cash or the accruals basis is used. For most smaller landlords, the cash basis is now the default basis.

Under the cash basis, capital expenditure can be deducted unless the disallowance is specifically prohibited (as in the case in relation to cars and land and property). Under the accruals basis, a deduction is not given for capital expenditure, although in limited cases capital allowances may be available. Capital expenditure would include improvements to the property and new furniture or equipment which does not replace old items.

Records should identify whether expenditure is capital or revenue and also whether it relates to private expenditure so that it can be excluded.

Records should also be kept of replacement domestic items and the nature of those items. A deduction is available on a like-for-like basis.

Start date

Although the property rental business does not start until the property is first let, records should start as soon as expenditure is incurred in preparation for the letting.

As well as allowing relief for expenses incurred while the property is let, relief is also available for expenses which are related to the property rental business and which are incurred in the seven years prior to the start of the business. Relief is given on the same basis as for expenses incurred after the start of the property rental business; expenses can be deducted as long as they are incurred wholly and exclusively for the purposes of the property rental business. Capital expenditure is treated in accordance with rules applying to the chosen basis of accounts preparation.

Relief is available under the pre-trading rules, as long as:

  • the expenditure is incurred within a period of seven years before the date on which the rental business started
  • the expenditure is not otherwise allowable as a deduction for tax purposes
  • the expenditure would have been allowed as a deduction has it been incurred after the rental business had started

Relief is given by treating the expenses as if they were incurred on the first day of the property rental business.

Expenses incurred in getting a property ready to let can be significant. It is important that accurate records are kept of all expenditure incurred wholly and exclusively for the purposes of the let from the outset so that valuable deductions are not overlooked.

Partner note: ITTOIA 2005, s. 57; CTA 2009, s. 61.

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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 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/816196/Changes_to_ancillary_reliefs_in_Capital_Gains_Tax_Private_Residence_Relief_-_Draft_legislation.pdf).

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