The case Salisbury House Estate Ltd. v Fry established that income chargeable as rental income cannot be charged as trading income. This distinction can also be summed up by the simple question, “Is the property held to derive rent or held to sell to realise a profit”.
The income is chargeable on the person receiving or entitled to the income. Any losses are carried forward and set against the profits of the next year and any losses remaining unrelieved are carried forward until used up, whilst the business continues.
All UK rental income is treated as relating to a single business. This applies whether the income is from a property portfolio or a single property. It matters not whether the letting is from furnished or unfurnished property.
The profits are computed using the rules for the computation of trading profits:
- The profit is to be calculated using generally accepted accounting practice.
- The income received has to be converted to the income receivable for the year.
- Only those expenses incurred wholly and exclusively for the rental business are allowable.
- As for trading profits capital items are not allowable but certain items of capital income are chargeable.
- Capital allowances are allowed as deductions from the rental income.
Usually property is held as “joint tenants”. Each spouse or civil partner has equal rights over the property and when one dies their interest is transferred automatically to the other.
Take legal advice but you can change this to “tenants in common” which means that each spouse or civil partner has a separate share in the property which, on death, can be disposed of however the deceased wishes and does not automatically go to the other spouse or civil partner.
Property held jointly by a husband and wife couple or civil partnership is treated as being owned equally for tax purposes unless actually held in some other proportion.
If, however, the property is actually held in unequal shares, the couple or civil partnership can make a declaration to that effect on form 17 and then the income can be taxed on the basis of the actual beneficial shares.
Where one party in a married couple or civil partnership owns a buy to let property and one spouse or civil partner is liable to a higher rate of tax than the other but does not want to equalise the capital interest which results in a transfer of income to the other spouse or civil partner, an advantage can be obtained by a simple gift of a small percentage of the equity e.g. 1%.
This means that the spouse or civil partner holding 99% will continue to receive 99% of the income and on sale 99% of the net sale proceeds.
For taxation, as the property is jointly owned, both spouses will pay tax on one half of the rent. This will switch some of the higher rate taxation to the other spouse or civil partner and use up the balance of their lower rate band.
Also remember that if that split is not advantageous they can elect to have their taxation based on their actual shares.
Can property ownership be a trade?
The answer is very difficult. In the UK the only way, as many flat let owners in our holiday towns found out, was to qualify as furnished holiday lettings.
To run a property as a trade you virtually need to run a hotel or the very least a bed and breakfast establishment.
Buy to let, even if you let several properties is not a “trade”; it certainly is a business.
It is doubtful that the mere arranging for someone to provide a service would amount to a trade. It may be different if several services are provided
The items allowable include:-
- Rent and similar items paid out of the rents received.
- Repairs, redecoration and maintenance.
- The cost of items incurred under the terms of the lease.
- Any insurance premiums incurred on the property. Premiums for loss of rent insurance are not allowable.
- Accountancy fees for the preparation of the letting accounts.
- The cost of rent collection and management generally. For motor expenses, keep a mileage log and charge at the authorised rate of 40p per mile for the first 10,000 miles and 25p thereafter. Under management you can claim the cost of advertising, telephone calls and all the motoring to include showing prospective tenants around.
- Legal fees are allowable for lease renewals where the lease is not in excess of 50 years. Now that letting is treated as a business, it is understood that the cost of a new lease is also allowable where the term is for less than 21 years.
- Legal fees include the cost of rent reviews, valuations, legal costs for chasing arrears of rent and the costs of eviction of tenants.
- If you incurred expenses before the letting commenced you can claim them so long as they would qualify under the normal rules i.e. so long as the property was capable of being let when acquired. I can never understand why on acquisition few people consider the tax implications. With the proper records it should be easy to withstand a challenge from HMR&C. They must be incurred in the seven year period before the letting commenced and they are treated as being incurred on the first day letting commenced.
Landlords can claim the cost of:-
- The installation of loft or cavity wall installation.
- The installation of hot water systems and draught proofing.
- The installation of floor insulation.
The maximum allowable amount is 1,500.
As property income is treated as being from a business the interest allowable must comply with the rules for calculating trading profits.
Usually a property is purchased with a mixture of funds introduced by the individual and finance secured on the property. The money introduced can be withdrawn from the business tax free when funds allow.
Alternatively these funds could be replaced with borrowed monies and tax relief will still be granted on the interest whether secured on that property, on the individual’s private residence or any other way and no matter for what purpose it is used.
Beware, the amount of the withdrawal is limited to the capital introduced and cannot be part of the “profit” represented by inflation. Also a restriction could be made by HMR&C if the gearing is so high that the letting is unlikely to ever make a profit.
Rent a room:
Rent received from the furnished letting of part of your residence is exempt from tax so long as it does not exceed 4,250 for the relevant tax year.
It can, however, apply to individuals where they receive income jointly with another individual e.g. husband and wife or civil partner running a bed and breakfast or small guest house. The limit will then be divided by two.
Where this limit is exceeded the excess is treated as taxable rental income. For example if the rent totals 5,000 the excess over the limit of 750 is taxed.
No deductions are permitted. The “rent” includes any payments received for any services e.g. meals, cleaning and laundry. It is open to you to calculate the assessable profit in the normal way.
Always calculate the profit both ways and adopt the most beneficial e.g. where a loss arises.
Clearly the rent a room calculation cannot produce a loss but if the normal method of the gross rents less expenses produces a loss you can disclaim the relief and claim the loss instead.
Many properties are let with the benefit of the use of furniture. The tenant does not have the cost of furnishing the accommodation, e.g. student lets. The rental profit is determined in the same way as for a property let without furniture.
The relief for the cost of the furniture is either the cost of replacement furniture where no claim was made for the original cost or a deduction of an amount equal to 10% of the rent received.
Rent is defined as the payments by the tenant less any costs met by the landlord in respect of council tax, water rates and other services which are the responsibility of the tenant.
The provision of the furniture etc. does not turn the business into a trade!! Some people overlook to claim capital allowances on items that are an integral part of the building, for example central heating systems.
There is a distinction between the main fixtures that are standard fittings in a modern building and the equipment required for the trade of the occupier.
The writing down allowance for the new integral fixtures is 10%.
The profit from the letting of a house does not usually amount to the carrying on of a trade and this was tested and confirmed by the decision in two tax cases.
The legislation was then amended to give relief and to get the equivalent tax advantages of those that apply to a trade. The letting must qualify as furnished holiday letting.
Properties considered to be within the legal definition have considerable tax advantages. Firstly the profits or losses are not considered to be taxable as rental income but are treated as trading profits or losses.
The criteria are that the accommodation must be in the EU and must be let on a commercial basis with the tenant entitled to the use of furniture.
The property must be available for letting for at least 140 days and must be actually let for 70 days during a period of at least seven months; each occupation must not exceed 31 days by the same person in any period of 7 months.
What are the advantages?
- interest can be claimed on acquiring the accommodation as a trading expense
- if losses are incurred in the first four years they can be carried back and set against the income of up to three years earlier.
- profits qualify for personal pension premium relief.
- for capital gains purposes the chargeable gains arising from the sale of the property can be rolled over.
The legislation set out to help tourism and I cannot see that the legislation precludes losses being allowed where the owner lives in the property for up to five months in the year.
You will note that the legislation does not refer to property but to “accommodation”. If you can convince HMR&C that a boat or caravan is let as “furnished holiday accommodation” then you can achieve the same advantages as if it were a property.
In addition, provided they both move, or for a caravan it is on a registered holiday caravan site, then you can claim capital allowances to include the Annual Investment Allowance, which is 100% for the first 100,000.
Capital allowances can be claimed for plant and machinery used wholly or partly for the purposes of the letting business. There is a 100% relief for expenditure of up to 100,000 per annum, “annual investment allowance”.
The writing down allowance is 20%.
There is a distinction between the main fixtures that are standard fittings in a modern building and the equipment required for the trade of the occupier. The writing down allowance for integral fixtures is 10%.
- Cold water systems.
- Lifts, escalators and moving walkways.
- Space and water heating systems.
- Electrical and lighting systems.
- External solar shading.
- Ventilation by power, air cooling or air purification systems.
When purchasing a property it is important to identify the correct category and to identify all the integral features.
If you repair an integral feature and the cost of the repair is more than 50% of the replacement cost it becomes capital expenditure. The good news is that this expenditure will qualify for the Annual Investment Allowance thus granting relief at 100% rather than 10%.
Also the timing of expenditure on repairs is important as you may be able to spread the cost over two different twelve month periods to maximise the relief.
There is a “Flat Conversion allowance” which is granted where empty space in a commercial building is converted into flats for residential use.
The relief applies where such a flat is renovated or where a conversion creates qualifying flats. The flat must be for short term lets and must not be of “high value”.
Claims are to be made in the same way as normal capital allowances; on the self-assessment return and within twelve months of the 31st January following the tax year end.
Companies can claim these allowances and where losses result they are set against the company’s total profits for the accounting period in which the allowances are claimed with any excess being carried forward and treated as rental business losses of the next accounting period.
Another 100% relief is available for the renovation or conversion of business properties that have been vacant for a year or more in disadvantaged areas. When planning your property investments these allowances should be taken into account.