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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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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The last thing you want for Christmas is an inheritance tax liability! Read this blog to make sure you don’t get caught.

Beware of triggering an IHT bill on Christmas gifts

When deciding what to give as Christmas gifts, the possibility of triggering an unintended inheritance tax liability is not one that immediately springs to mind. However, there are traps that may catch the unwary.

Income or capital

When making a gift, it is important to ascertain whether the gift is being made out of income or from capital. There is an inheritance tax exemption for normal expenditure from income. To qualify, the gift must be made regularly and only from surplus income. It is important that after making the gift you have sufficient income left to maintain your usual lifestyle. To avoid unwanted questions, it is a good idea to set up a regular pattern of giving and keep records to show that the gifts were made from income.

A gift that is made from capital – for example, from the proceeds from the sale of a property or a gift of a valuable antique – will reduce the value of the estate. Unless the gift falls within the ambit of another exemption, the gift will be a potentially exempt transfer (PET) and will be taken into account in working out the inheritance tax due on the estate if you die within seven years of making the gift.

Gifts to spouses and civil partners

The inter-spouse exemption protects gifts between spouses and civil partners. Consequently, gifts of any value can be given to a spouse or civil partner without worrying about the inheritance tax implications.

Annual allowance

Everyone has an annual allowance for inheritance tax purposes of £3,000. The annual allowance enables you to give away £3,000 every year in assets or cash, in addition to gifts covered by other exemptions, without it being added to the value of your estate.

You can also carry forward the annual exemption to the following year if it is not used, so if you did not use it in the last tax year, you can make gifts of up to £6,000 this year without having to worry about inheritance tax. However, any unused allowance can only be carried forward to the following tax year, after which it is lost.

Small gifts

The small gifts exemption enables you to make gifts of up to £250 a year to as many people as you like without having to keep a tally for inheritance tax purposes. However, the same person cannot benefit from a small gift of £250 in addition to the annual gifts allowance.

Wedding gifts

If a family wedding is on the horizon, you can take advantage of the wedding gifts exemption to make further gifts. To qualify, the gifts must be made before the wedding not afterwards. The exempt amounts are set at £5,000 for gifts to a child, £2,500 for gifts to a grandchild or great-grandchild and at £1,000 for a gift to another relative.

Partner note: IHTA 1984, ss. 18 – 22.

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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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HMRC have given new guidance on how stamp duty is applied to residential property which has land. Take a look at our short blog if you’re thinking of purchasing a property that has features such as farmland, stables or orchards.

Grounds and gardens for SDLT

Stamp duty land tax (SDLT) on residential property also applies to land that form the garden or grounds of the property. To ensure that the right rate of SDLT is applied, it is therefore important to ascertain whether any land purchased with a property constitutes its garden or grounds. The rules here are not the same as those applying for capital gains tax private residence relief.

HMRC have recently updated their guidance in this area.

Status of the building

The first step in determining whether land is residential land is to determine the status of the associated building. If the building is a residential property for SDLT purposes, all land forming part of the ‘garden or grounds’ is residential property. Consequently, if at the time of purchase the property is not capable of being used as a dwelling, or is in the process of being constructed or adapted for residential use, the building is not residential property for SDLT purposes and any associated land is also not residential property.

Status of the land

Land that constitutes the ‘garden or grounds’ of a building which counts as residential property for SDLT purposes will also be residential property, and therefore subject to SDLT residential property rates, even if it is sold separately from the building.

The key date is the date of the transaction. However, past use of the land is taken into account by HMRC is order to establish the relationship between the land and the building. Future or planned future use is not relevant, although where use changes over time, the status of the land may also change.

No single factor

In deciding whether land counts as ‘garden or grounds’ a range of factors will come into play – there is no single determining factor. However, not all factors will carry equal weight. It is necessary to consider how the land is used.

Questions to ask include:

  • Is there evidence that the land has been actively and substantially exploited on a commercial basis?
  • If the activity could be for leisure or commercial purposes, such as beekeeping or equestrian use, is there evidence of commercial use?
  • Has a lease been granted to a third party for exclusive use of the land? This would suggest that the land is unlikely to be ‘garden or grounds’.
  • Is the land of a type which would be expected to be ‘garden or grounds’ unless commercial use is established, such as land used as a paddock or orchard?
  • Is the land agricultural land which is sitting fallow? Such land is unlikely to be regarded as ‘garden or grounds’.

Outbuildings

The nature and layout of any outbuildings can be significant in determining whether land is ‘garden or grounds’. The presence of domestic outbuildings, areas laid out for hobbies, small orchards or stables and paddocks suitable for leisure use would indicate that the land is ‘garden or grounds’. However, the presence of commercial farming, commercial woodland, commercial equestrian use or other commercial use would suggest the contrary.

Size and proximity to dwelling

Physical proximity to the dwelling makes it more likely that the land is ‘garden or grounds’. However, land separated from the building may also fall into this category.

The size of the land in relation to the size of the building will also be relevant – a small cottage is unlikely to have a garden and grounds of many acres but a stately home may do.

The overall picture

In deciding the character of the land for SDLT purposes, it is necessary to look at the overall picture that emerges at the transaction date.

Partner note: FA 2003, s. 116(1)(a); HMRC’s Stamp Duty Land Tax Manual SDLTM00440ff.

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Property Business – What SIC code should I use for my property Company ?

A SIC code stands for Standard Industrial Classification code, and classifies your business activity at Companies House. SIC code for a company can be changed at any time and be amended when you file your next  Confirmation Statement. While forming a company to run your property business, you will be asked to provide SIC code which closely describes your business activities. There are various reasons to choose an appropriate SIC code so as to avoid any complexities later on with tax authorities and Lenders.

Practically, there are only four: 68100, 68209, 68320 and 68310, and here’s a brief explanation of their classification.

1. SIC code 68100 is for the buying and selling of own real estate; so, if you’re going to be flipping and trading,  this would be the code for you. So if you intend to buy properties to resell, then this is the appropriate SIC code.

2. SIC code 68209 is for the letting and operating of own or leased real estate. In other words, for buying and holding property and renting it out. So if you are buying a property to hold as an investment (single BTLs or HMOs) or if you are using Rent to Rent strategy this will be the SIC code for  your company.

3. SIC code 68320 is for the management of real estate on a fee or contract basis. So, for example if you’re going to set up your own management company, then this would be the right classification for you.

4. SIC code 68310 is for real estate agencies. So, for all the deal sourcers/packagers who act as an agent for investors.

As you can see, these codes effectively tell Companies House what a business is going to be doing from a tax point of view. You can choose up to a maximum of four SIC codes for one company. SIC codes also play a crucial role with lenders/Finance providers – again, these codes let lenders know what activity a property company is going to undertake, and will help lenders assess whether they want to lend to you or not.There are issues however with having multiple property activities running through the same company, and it would be wise to seek professional advice to ensure your company structure is correct and efficient from the outset, with particular consideration to Capital Gain Tax and business property relief.

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Inspired by Grand Designs? You are entitled for a VAT refund if you build your own home.

VAT refunds for DIY builders

If you build your own house or convert an existing property into a home, you may be eligible to apply for a VAT refund on building materials and services. You do not need to be VAT registered to claim a refund.

What qualifies?

Refunds can be claimed in respect of building materials that are incorporated into the building and which cannot be removed without tools or without damaging the building. Refunds are available for materials used to build both new homes and for certain conversions.

A new home will qualify if it is separate and self-contained and you build it for you and your family to live in. The property must not be used for business purposes, although you are permitted to use one room as a home office.

Conversions will qualify if the property was previously used for non-residential purposes and is converted for residential use. Conversions of residential building will only qualify if they have not been lived in for at least 10 years.

Where you use a builder, the builder’s services will normally be zero-rated where they work on a new home. However, you can claim a refund for VAT charged by a builder working on a conversion.

What does not qualify?

Refunds are not available in respect of:

  • materials or services on which no VAT is payable because they are zero-rated or exempt;
  • professional fees, such as architects’ fees or surveyors’ fees;
  • costs of hiring machinery or equipment;
  • building materials which are not permanently attached to or part of the building;
  • fitted furniture, some gas and electrical appliances, carpets and garden ornaments.

A refund is also denied if the building is not capable of being sold separately, for example, as a result of planning restrictions.

How to claim

The claim is made on form 431NB where it relates to a new build and on form 431 where it relates to a conversion. The forms are available on the Gov.uk website. The claim must be made within three months of the date on which the building work was completed.

You must include all the relevant supporting documentation with your claim, such as valid VAT invoices to support the amount claimed. The refund will normally be issued within 30 days of making the claim.

Partner note: www.gov.uk/vat-building-new-home/eligibility.

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Today’s blog covers the serious curtailment to letting relief for landlords coming April 2020 – read more here.

Curtailment of letting relief

Landlords have been hit with a number of tax hikes in recent years, and this trend shows no signs of abating. From 6 April 2020, lettings relief – a valuable capital gains tax relief which is available where a property which has at some point been the owner’s only or main residence is let out – is seriously curtailed.

Now

Under the current rules letting relief applies to shelter part of the gain arising on the sale of a property which has been let out as residential accommodation and which at some time was the owner’s only or main residence. The amount of the letting relief is the lowest of the following three amounts:

  • the amount of private residence relief available on the disposal;
  • £40,000; and
  • the gain attributable to the letting.

Under the current rules, periods of residential letting count regardless of whether or not the landlord also lives in the property.

From 6 April 2020

From 6 April 2020, letting relief will only be available where the owner of the property shares occupancy with a tenant. From that date, lettings relief is available where at some point the owner of the property lets out part of their main residence as residential accommodation and shares occupation of that residence with an individual who has no interest in the residence.

To the extent that a gain that would otherwise be chargeable to capital gains tax because it relates to the part of the main residence which is let out as residential accommodation, the availability of lettings relief means that it is only chargeable to capital gains tax to the extent that it exceeds the lower of:

  • the amount of the gain sheltered by private residence relief; and
  • £40,000.

Example 1

Tom owns a property which he lives in as his main residence. He lived in it for a year on his own, then to help pay the bills he let out 40% as residential accommodation.

In June 2020 he sells the property realising a gain of £189,000. He had owned the property for five years and three months (63 months).

The final nine months of ownership are covered by the final period exemption – this equates to £27,000.

For the remaining 54 months, private residence relief is available for the first 12 months and 40% of the remaining 48 months – a total of 31.2 months (12 + (40% x 48)). This is worth £93,600. (31.2/63 x £189,000).

Private residence relief in total is worth £120,600 (£27,000 + £93,600).

The gain attributable to the letting is £68,400 (£189,000 – £120,600). This is taxable to the extent that is exceeds £40,000 (being the lower of £40,000 and £120,600).

Thus the letting relief is worth £40,000 and the chargeable gain is £28,400.

Example 2

Lucy buys a flat for £300,000 which she lives in for one year as her main residence. She then buys a new home which she lives in as her main residence and lets the flat out for three years, before selling it and realising a gain of £96,000.

If she sells it before 6 April 2020, she will be entitled to private residence relief of £60,000 (30/48 x £96,000). The final 18 months are exempt as she lived in the flat for 12 months as her main residence. The gain attributable to letting is £36,000, all of which is sheltered by lettings relief (as less than both private residence relief and £40,000).

If she sells the property after 6 April 2020, the final period exemption only covers the last nine months, reducing the private residence relief to £42,000 (21/48 x £96,000). The remainder of the gain of £54,000, which is attributable to the letting, is chargeable to capital gains tax as letting relief is no longer available as Lucy does not share her home with the tenant.

Consider realising a gain on a let property which has also been a main residence prior to 6 April 2020 to take advantage of the letting relief available prior to that date where a landlord does not share the accommodation with the tenant.

Partner note: TCGA 1992, s. 224; 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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Do you spend more than 6 months of the year outside the UK? Make sure you’re compliant

Non-residents landlord scheme

A non-resident landlord is a landlord who lets out property in the UK but spends more than six months in the tax year outside the UK. A special tax scheme – the non-residents landlord scheme – applies to these landlords. Under the scheme, tax must be deducted by a letting agent or tenant from the rent paid to the non-resident landlord and paid over to HMRC.

Tenants

A tenant falls within the NRL scheme where the landlord is a non-resident landlord and the rent paid to the landlord is more than £100 a week. Where the rent is less than £100 a week (£5,200 a year), the tenant is not required to deduct tax from the rent (unless told to do so by HMRC). The tenant is also relieved of the obligation to deduct tax if HMRC have notified the tenant in writing that the landlord can receive the rent without tax being deducted; however the tenant must still register with HMRC and complete an annual return.

Where the tenant pays rent to a letting agent, it is the letting agent rather than the tenant who must operate the scheme.

Letting agents

Letting agents must also operate the NRL scheme where they collect rent on behalf of a non-resident landlord, regardless of how much rent they collect (unless HMRC have informed the letting agent in writing that the landlord can receive the rent without tax being deducted).

A letting agent is someone who helps the landlord run their business, receives rent on their behalf or controls where it goes and who usually lives in the UK.

Complying with the scheme

To comply with the scheme, tenants and letting agents must

  • register with the HMRC Charity, Savings and International department within 30 days of the date on which they are first required to operate the scheme– letting agents should use form NRL4i and tenants should write to HMRC
  • work out the tax to be deducted each quarter
  • send quarterly payments of tax deducted to HMRC Accounts Office, Shipley
  • send a report to HMRC and the landlord by 5 July after the end of the tax year on form NRLY
  • provide the non-resident landlord with a certificate of tax deducted each year (on form NRL6)
  • keep records for four years to show that they have complied with the scheme

Calculating the tax

Tax should be calculated on a quarterly basis on:

  • any rental income paid to the landlord in the quarter
  • any payments that they make in the quarter to third parties which are not ‘deductible payments’

Deductible payments are those that the tenant or letting agent can be ‘reasonably satisfied’ will be deductible in computing the profits of the landlord’s property rental business. Reassuringly, in their guidance, HMRC state that they ‘do not expect letting agents and tenants to be tax experts’.

The quarters run to 30 June, 30 September, 31 December and 31 March. The tax deducted must be paid over to HMRC within 30 days of the end of the quarter.

The non-resident landlord

The non-resident landlord can set the tax deducted under the scheme against that payable on the profits of his or her property rental business. Partner note: The Taxation of Income from Land (Non-residents) Regulations 1995 (SI 1995/2002).

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