Give to charity to reduce your inheritance tax bill

Making gifts to charity can be an effective way to reduce the amount of inheritance tax (IHT) payable on your estate. Charitable gifts can work to reduce the IHT payable in two ways:

  • reducing the value of the net estate chargeable to IHT; or
  • where the gifts to charity are worth at least 10% of the net estate at death, reducing the rate at which inheritance tax is payable.

Lifetime gifts and bequests on death made to qualifying charities and registered housing associations are exempt from inheritance tax, provided that the gift was made outright.

Qualifying charities

A qualifying charity is one that meets the following conditions:

  • it is a charity that is established in the EU or other specified country;
  • it meets the definition of a charity under the law of England and Wales;
  • it is regulated in the country of establishment, if that is a requirement of that country;
  • its managers are fit and proper persons to be managers of the charity.

HMRC assumes that people appointed by charities are fit and proper persons unless they hold information to show otherwise.

Reducing the net estate

Where a gift is made to charity, the net estate is reduced by the amount of the gift. This can be effective in reducing the amount of inheritance tax payable where the value of the estate exceeds the nil rate band (currently £325,000), plus the residence nil rate band, where available.

The gift to charity reduces the net value of the estate.

Example

Elsie died on 1 December 2018 leaving an estate worth £475,000. She had never married and had no children. In her will she left £5,000 to a qualifying charity, and the balance of her estate to her niece Susan.

Her total estate of £475,000 is reduced by the charitable gift to £470,000. After deducting her nil rate band of £325,000, her taxable estate is £145,000 (on which IHT of £58,000 (£145,000 @ 40%) is payable. The charitable gift reduced the IHT payable on her estate by £2,000 (£5,000 @ 40%).

A reduced rate of IHT

Where the charitable gift is at least 10% of the net estate, the rate of inheritance tax is reduced from 40% to 36%. The net estate is the value of the estate after deducting any debts, liabilities, reliefs and exemptions and the nil rate band and residence nil rate band, as appropriate.

Example

Alfred died on 20 October 2018. He left an estate of £700,000. He had never married and had no children. In his will he left £40,000 to a qualifying charity, with the balance of his estate split equally between his three nephews.

Total estate £700,000
Less: qualifying donation to charity (£40,000)
  £660,000
Less: nil rate band (£325,000)
Taxable estate £335,000

The value of the estate in excess of the nil rate band is £375,000 (£700,000 – £325,000). This is the baseline amount. The qualifying donation to charity of £40,000 is more than 10% of this amount. Thus, the rate of inheritance tax on the taxable estate is reduced from 40% to 36%.

Consequently, the inheritance tax payable on Alfred’s estate is £120,600 (£335,000 @ 36%).

Complications

Where the residue of the estate is partially exempt, for example if it left to a surviving spouse or to a charity, and the Will contains other legacies are left free of tax, it is necessary to gross up such legacies when testing whether the 10% test is met. HMRC produce a calculator which can be used to check whether the test is met. It is available on the Gov.uk website at www.gov.uk/inheritance-tax-reduced-rate-calculator.

Here’s how to earn tax-free money through doing something you love.

Spare time earnings may be tax-free

The new trading tax allowance for individuals of £1,000 was introduced from 6 April 2017 and applies for the 2017/18 tax year onwards. In broad terms, the allowance means that individuals with trading income below the annual threshold may not need to report it to HMRC and may not need to pay tax on it.

This allowance may be particularly useful to individuals with casual or small part time earnings from self-employment, for example, people working in the ‘gig economy’ (Deliveroo workers and such like), or small-scale self-employment such as online selling (maybe via eBay or similar). It means that:

  • individuals with trading income of £1,000 or less in a tax year will not need to declare or pay tax on that income
  • individuals with trading income of more than £1,000 can elect to calculate their profits by deducting the allowance from their income, instead of the actual allowable expenses.

Practical implications of the allowance include:

  • where actual expenses are less than £1,000, deducting the trading allowance will be beneficial, whereas if actual expenses are more than £1,000, deducting the actual expenses will give a lower profit figure, and ultimately a lower tax bill
  • where income is less than £1,000, but the individual makes a loss, an election for the allowance not to apply may be made – in this case, the loss in the usual way and include the details on their tax return, meaning that loss relief is not wasted

Example – Income less than £1,000

Graham enjoys picture-framing in his spare time, and he occasionally frames prints for family and friends for a small fee. During the 2018/19 tax year he received income of £700 from this source, and his expenditure on framing equipment amounted to £300. As Graham’s trading income is less than £1,000, he does not need to report it to HMRC and he does not need to pay tax or national insurance contributions (NICs) on it.

Example – Income exceeding £1,000

Mary enjoys baking and makes celebration cakes to order in her spare time. In 2018/19, her income from cake sales is £1,500 and she incurred expenses of £300. As Mary’s expenditure is less than £1,000, she will be better off if she claims the trading allowance. Her taxable profit will be £500 (£1,500 less the trading allowance of £1,000).

More than one source of trading income

Although the trading allowance may work well for many small-scale traders, care must be taken where a person’s main source of income is from self-employment and their secondary income is from a completely separate small-scale business. HMRC will combine income from all trading and casual activities when considering the trading allowance. In this type of situation, where the allowance is claimed, the individual will not be able to claim for any expenditure, regardless of how many businesses they have and how much their total business expenses are.

Example – More than one income source

Mark is a self-employed car mechanic and has income of £30,000 in 2018/19. His business expenditure for the year is £10,000. In his spare time, Mark buys and sells old collectable car magazines via the internet. During 2018/19 he received net income of £1,000 from this source. If Mark claims the trading allowance against his part time income, he will be unable to claim expenses of £10,000 against his car mechanic income, and his taxable profit for the year will be £30,000. If he doesn’t claim the trading allowance, his taxable profit for the year will be just £21,000.

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The CGT annual exemption – use it or lose it!

Capital gains tax (CGT) is normally paid when an item is either sold or given away. It is usually paid on profits made by selling various types of assets including properties (but generally not a main residence), stocks and shares, paintings, and other works of art, but it may also be payable in certain circumstances when a gift is made.

Some assets are exempt from CGT, including assets held in an Individual Savings Account (ISA), betting, lottery, or pools winnings, cash held in sterling, jewellery, antiques, and other personal effects that are individually worth £6,000 or less.

The most common method for minimising a liability to capital gains tax is to ensure that the annual exemption is fully utilised wherever possible. Whilst this is relatively straight-forward where only capital gains are in question, the computation can be slightly more complex where capital losses are also involved.

Most people are entitled to an annual CGT exemption, which means that no CGT is payable on gains up to that amount each year. For 2018/19, the limit is £11,700 and it will rise to £12,000 in 2019/20.

Eligible individuals each have their own exemption, so for jointly owned assets, there is scope for spouses and civil partners to exempt £23,400 worth of gains in 2018/19, rising to £24,000 in 2019/20.

However, the annual exemption is good only for the current tax year – you can’t carry it forwards or backwards – so if it isn’t used in a particular tax year, it will be lost. If you are planning to make a series of disposals, for example disposing of a portfolio of shares, you may want to consider the timing of sales between two or more tax years to use up as much and as many annual exemptions as possible.

Moving gains

Although inter-spouse/civil partner transfers are not technically exempt from CGT, the mechanics of computation are such that no CGT charge arises on such transfers. This treatment requires the spouses/civil partners to be married and living together. It should also be noted that if the spouse or partner later sells the asset, they may have to pay CGT at that time.

Example

Grace, a higher rate taxpayer, disposes of 500 shares in ABC plc in 2018/19 making a capital gain of £30,000. After deducting the annual exemption (£11,700), her chargeable gain is £18,300. As Grace is a higher rate taxpayer, she will pay CGT at the 20% rate, and £3,660 will be payable on the gain.

If prior to sale, Grace transferred half of the shares to her spouse Bob, a basic rate taxpayer, the capital gains tax situation would be significantly different. Both Grace and Bob will be able to use their annual CGT exemptions. They will each have a chargeable gain of £3,300 (after the annual exemption). Since Bob is a basic rate taxpayer, subject to his taxable income and chargeable gain being below the basic rate band, he will pay CGT at 10%.

Capital gains tax on the sale of the shares would be charged as follows:

 Grace:            Chargeable gain of £3,300 at 20% = £660

Bob: Chargeable gain of £3,300 at 10% = £330

Total CGT payable £990

Transferring half the shares to Bob potentially saves tax of £2,670.

Whilst it is permissible to organise your financial affairs in such a way as to minimise tax payable, strict anti-avoidance rules do exist. Seeking professional advice is always strongly recommended prior to undertaking any transactions of this nature.

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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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Salary v dividend for 2019/20

A popular profits extraction strategy for personal and family companies is to extract a small salary, taking further profits as dividends. Where this strategy is pursued for 2019/20, what level should be the salary be set at to ensure the strategy remain tax efficient?
Salary
As well as being tax effective, taking a small salary is also advantageous in that it allows the individual to secure a qualifying year for State Pension and contributory benefits purposes.
Assuming the personal allowance has not been used elsewhere and is available to set against the salary, the optimal salary level for 2019/20 depends on whether the employment allowance is available and whether the employee is under the age of 21. The employment allowance is set at £3,000 for 2019/20 but is not available to companies where the sole employee is also a director (meaning that personal companies do not generally benefit).
In the absence of the employment allowance and where the individual is aged 21 or over, the optimal salary for 2019/20 is equal to the primary threshold, i.e. £8,632 a year (equivalent to £719 per month). At this level, no employee’s or employer’s National Insurance or tax is due. The salary is also deductible for corporation tax purposes. A bonus is that a salary at this level means that the year is a qualifying year for state pension and contributory benefits purposes – for zero contribution cost. Beyond this level, it is better to take dividends than pay a higher salary as the combined National Insurance hit (25.8%) is higher than the corporation tax deduction for salary payments.
Where the employment allowance is available, or the employee is under 21, it is tax-efficient to pay a higher salary equal to the personal allowance of £12,500. As long as the personal allowance is available, the salary will be tax free. It will also be free of employer’s National Insurance, either because the liability is offset by the employment allowance or, if the individual is under 21, because earnings are below the upper secondary threshold for under 21s (set at £50,000 for 2019/20). The salary paid in excess of the primary threshold (£3,868) will attract primary contributions of £464.16, but this is outweighed by the corporation tax saving on the additional salary of £734.92 – a net saving of £279.76. Once a salary equal to the personal allowance is reached, the benefit of the corporation tax deduction is lost as any further salary is taxable. It is tax efficient to extract further profits as dividends.
Dividends
Dividends can only be paid if the company has sufficient retained profits available. Unlike salary payments, dividends are not tax-deductible and are paid out of profits on which corporation tax (at 19%) has already been paid.
However, dividends benefit from their own allowance – set at £2,000 for 2019/20 and payable to all individuals regardless of the rate at which they pay tax – and once the allowance has been used, dividends are taxed at lower rates than salary payments (7.5%, 32.5% and 38.1% rather than 20%, 40% and 45%).
Once the optimal salary has been paid, dividends should be paid to use up the dividend allowance. If further profits are to be extracted, there will be tax to pay, but the combined tax and National Insurance hit for dividends is less than for salary payments, making them the preferred option.

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Does the marriage allowance apply to you?

The marriage allowance can be beneficial to married couples and civil partners on lower incomes. Claiming the marriage allowance is worth up to £238 in 2018/19 and £250 in 2019/20.
Nature of the allowance
The marriage allowance allows one spouse of civil partner to transfer 10% of their personal allowance (rounded up to the nearest £10) to their partner if they are unable to utilise the full allowance. However, it is only available where the recipient pays tax at the basic rate – couples where one party has no income and the other party is a higher or additional rate taxpayer cannot benefit from the allowance.
A personal can transfer 10% of their personal allowance to their spouse or civil partner if:
• they are married or in a civil partnership;
• they have not used up all of their personal allowance (set at £11,850 for 2018/19 and at £12,500 for 2019/20);
• and their partner pays tax at the basic rate.
For Scottish taxpayers, the marriage allowance is available if the recipient pays tax at the Scottish starter, basic or intermediate rates.
For 2018/19 the personal allowance is £11,850 and the marriage allowance is £1,190. For 2019/20, the personal allowance is £12,500 and the marriage allowance is £1,250.
Impact of the marriage allowance
Where the marriage allowance is claimed, the transferor’s personal allowance for the year is reduced by the amount of the allowance and the transferees personal allowance is increased by the amount of the allowance. Instead of that portion of the personal allowance being wasted, it is set against the transferee’s income, saving tax at the basic (or relevant Scottish) rate.
Example
Lauren is a stay-at-home mum. She has no income in either 2018/19 or 2019/20.
Her husband Joe works as an electrician earning £20,000 a year.
They claim the marriage allowance for both 2018/19 and 2019/20.
For 2018/19, the allowance is £1,190. By claiming the allowance, Lauren’s personal allowance is reduced to £10,660 (£11,850 – £1,190) and Joe’s personal allowance is increased to £13,040 (£11,850 + £1,190). Their combined personal allowances remain at £23,700, but utilising the marriage allowance to increase Joe’s allowance while reducing Lauren’s saves them £238 (£1,190 @ 20%) in tax.
If they claim the marriage allowance of £1,250 for 2019/20, Lauren’s personal allowance will fall to £11,250 (£12,500 – £1,250), while Joe’s personal allowance will increase to £13,750. Claiming the allowance will save them tax of £250 (£1,250 @ 20%) for 2019/20.
The allowance will still be effective where the partner with the lower income does not fully utilise the allowance, even if as a result, they have some tax to pay as a result of making the claim.
Example
In 2018/19, Max has income of £11,000 and his wife Amy has income of £17,000. Claiming the marriage allowance will reduce Max’s personal allowance to £10,660, meaning he will pay tax of £68 ((£11,000 – £10,660) @ 20%). However, Amy’s personal allowance will increase to £13,040, saving her tax of £238. As a couple they are £170 better off (£238 – £68).
How to claim
The marriage allowance can be claimed online: see www.gov.uk/apply-marriage-allowance. Once a claim is made it will apply automatically for subsequent tax years, unless cancelled or circumstances claim. A claim can be backdated to include any tax year since 5 April 2015 for which the qualifying conditions are met.
The allowance can also be claimed for the year in which one partner dies.
Impact on tax codes
Where the marriage allowance is claimed, both the transferor’s and transferee’s tax code are amended as a result. A code with a ‘M’ suffix denotes that the individual has received the marriage allowance, whereas a ‘N’ suffix denotes that the individual has transferred 10% of their personal allowance to their spouse or civil partner.
In the above example, Lauren would have a tax code of 1066N for 2018/19, while Joe’s tax code would be 1,304M. For 2019/20, Lauren’s tax code would be 1125N, while Joe’s tax code would be 1375M.

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Directors’ NICs – the correct way to pay

The non-cumulative nature for calculating National Insurance Contributions (NICs) makes it possible to manipulate earnings to reduce the overall amount payable by taking advantage of the lower rate of primary Class 1 contributions payable once the upper earnings limit has been reached. For example, an employee who is paid £3,000 each month of the year will pay considerably more in primary contributions than someone who is paid £600 for 11 months and £29,400 for one month, even though their total earnings for the year are the same.

Company directors often have greater scope to influence the time and amount of payments they receive as earnings, which potentially gives them the ability to avoid primary Class 1 contribution liability by astute use of the earnings period rules. For this reason, therefore, special rules exist which provide that a director’s earnings period is a tax year, even if he or she is paid, say, monthly or leaves the company during the year.

The only exception to the above rule is where a director is first appointed during the course of a tax year. Where this happens, the earnings period is the period from the date of appointment to the end of the tax year, measured in weeks. The calculation of the earnings period includes the tax week of appointment, plus all remaining complete weeks in the tax year (i.e. week 53 is ignored for this purpose). This is known as the pro rata earnings period.

Example

Frank is appointed to the board of directors of Widgets Ltd in week 44 of the tax year. The primary threshold and upper earnings limit are calculated by multiplying the weekly values by 9, because the earnings period starts with the week of appointment. This means that in 2018–19, Frank will pay NIC at the main rate of 12% on his director’s earnings between £1,458 (9 × £162) (the primary threshold) and £8,028 (9 × £892) (the upper earnings limit) and at the additional 2% rate on all earnings above £8,028 paid up to 5 April 2019.

The significance of being a company director is that an annual earnings period must be applied for NIC purposes. It is therefore important to be clear as to who the directors of a company actually are. For example, there may be persons within the organisation who are called directors, but for whom that is just an honorary title.

The definition of ‘director’ is wide and extends beyond someone registered as a director with Companies House. For these purposes a director means:

  • in relation to a company whose affairs are managed by a board of directors or similar body, a member of that board or similar body;
  • in relation to a company whose affairs are managed by a single director or similar person, that director or person; and
  • any person in accordance with whose directions or instructions the company’s directors (as defined above) are accustomed to act.

However, a person giving advice in a professional capacity is not treated as a director.

Companies can save time and money by calculating directors’ NIC in a similar way to other employees. Instead of paying very high levels of NIC on a short-term basis, directors who are paid regularly (e.g. directors who have contracts of service with their companies) can spread their contributions evenly throughout the tax year. The earnings period remains an annual earnings period, but contributions are made on account throughout the tax year. A recalculation on an annual basis is performed when the last payment is made and any outstanding National Insurance due is paid at that time.

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What can be done with business losses?

Providing a business is being undertaken on a commercial basis with a view to making a profit, it is generally possible to claim relief for trading losses.

Relief for trading losses may be obtained in a variety of ways, including:

  • set-off against other income in the same or preceding tax year, for example against employment or pension income;
  • carry-forward against subsequent profits of the same trade;
  • carry-back in the early years of a trade;
  • set-off against capital gains of the same or preceding tax year; or
  • carry-back of a terminal loss.

It is worth noting here that anti-avoidance rules mean that loss relief will be restricted for individuals who carry on a trade but spend an average of less than ten hours a week on commercial activities.

Cap on relief

Trade loss relief against general income, and early trade losses relief are two areas where claimable relief is capped. The cap is set at £50,000 or 25% of income (as defined in the legislation), whichever is greater.

The cap applies to the year of the claim and any earlier or later year in which the relief claimed is allocated against total income. The limit does not apply to relief that is offset against profits from the same trade or property business.

Early years of trade

Where a loss is incurred in any of the first four tax years of a new business, the loss can be carried back against total income of the three previous tax years, starting with the earliest year.

This relief often helps new businesses in the first few years of trading. If tax has been paid in any of the previous three years, for example from a previous employment, the taxpayer should be entitled to a repayment of tax.

Set against total income

Relief for the trading loss of a tax year can be claimed against the taxpayer’s total income of that tax year and/or the preceding tax year, in any order. This gives a certain amount of scope to maximise loss relief in the most beneficial way.

Where a claim is made to relieve profits in one basis period by losses of both the same basis period and a subsequent period, the claim for the loss in the same period takes precedence.

Where basis periods overlap, and a loss would otherwise fall to be included in the computations for two successive tax years (e.g. in the opening years of a business), it is taken into account only in the first of those years.

Relief is not normally available for farming and market gardening losses, where losses were also incurred in the previous five years (calculated before capital allowances).

Carry forward of losses

Where a trader makes a loss in a year, but does not have any other income against which the loss can be set, he or she can carry it forward indefinitely and use it to reduce the first available profits of the same business in subsequent years.

Setting losses against capital gains

A taxpayer can also set any losses arising from a business against any chargeable capital gains. The relief can be claimed for the tax year of the loss and/or the previous tax year. However, the trading loss first has to be used against any other income the taxpayer may have for the year of the claim (for example, against earnings from employment) in priority to any capital gains.

Incorporation

Where incorporation is being considered, it is usually permissible to carry forward any unused losses of the pre-incorporation business and set them off against the first available income derived from the new company.

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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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