Overview of some of the common tax issues on rental expenditure.
The general rule when calculating rental business profits is that expenses will be treated as revenue expenditure, provided that they are incurred wholly and exclusively for the purposes of the business and are not of a capital nature.
EXPENDITURE INCURRED BEFORE A PROPERTY IS FIRST LET OUT
The tax deductibility of expenditure incurred before a property is first let out depends on whether it is capital or revenue in nature.
Repairs to reinstate a worn asset will usually qualify as revenue expenditure, but where a property is purchased and is not in a fit state for use in the business until the repairs have been undertaken, that expenditure is likely to be capital.
Guidance on whether the cost of repairing an asset acquired in poor repair is capital or revenue can be found in the contrasting cases of The Law Shipping Co Ltd v CIR and Odeon Associated Theatres Ltd v Jones.
Although both companies purchased assets in poor condition, there were key differences between the two cases.
In Law Shipping, the company acquired a ship in poor condition that it would have to have repaired before it could use it. This was capital expenditure and as a result not allowable in calculating the trading profit.
In Odeon, the company was able to operate the cinemas for a number of years before it carried out the repairs and also the price paid was not reduced to reflect the state of repair. The expenditure was found to be allowable revenue expense.
Expenditure for water rates, council tax etc paid by the landlord before tenants moved in is treated as pre-letting expenditure and as a result allowable.
WEAR AND TEAR ALLOWANCE
If the property is let furnished, the landlord is able to claim a wear and tear allowance.
This is 10% of the ‘net’ rent and covers plant and machinery that a landlord would normally provide in a furnished accommodation, such as furniture, fridges, carpets and curtains.
‘Net’ rent is the total rent for the year, less any expenses paid by the landlord that would normally be borne by the tenant – for example, utility bills.
The wear and tear allowance relates to the additional furniture and fittings that make it a furnished letting. It does not apply to the fixtures that are an integral part of the buildings.
Fixtures integral to the building are those that are not normally removed by either tenant or owner if the property is vacated or sold. Examples include:
- immersion heaters
WHOLLY AND EXCLUSIVELY – COST OF TRAVEL TO VISIT THE PROPERTY
Revenue expenses are allowable deduction against rental income only if they are incurred wholly and exclusively for the purpose of letting.
Where expenditure has a dual private and business purpose, unless the business element can be clearly distinguished then the whole of the expenditure will be disallowed for tax purposes.
While reasonable costs for inspection visits are usually allowable, if the trip is mainly for private purposes and it is not possible to separate this private element from the business portion, then none of the cost is deductible.
Solicitors’ fees incurred to evict tenants or to recover rental income are treated as incurred wholly and exclusively for the purpose of the rental business and as a result are allowable.
Management fees/agents’ fees will be fully tax deductible. If the landlord chooses to advertise his property privately, this cost is also allowable.
COST OF REPLACING FURNITURE, FIXTURES AND FITTINGS
The cost of replacing like with like is an allowable revenue expense.
However, if the replacement represents an improvement of the original asset, the cost is not allowable.
The expense will remain allowable if the improvement results from changes in technology over time.
So, if a new kitchen is fitted that performs the same job as the original kitchen, the cost is allowable. However, if it the kitchen has been upgraded and/or designed to increase functionality (such as increase storage space), the cost is not allowed.
The cost of a new boiler is usually allowable (even if it is more efficient than the previous boiler due to the improvement of technology over time).
However, if the boiler is used to service the increased space area of a house that has been extended, none of the cost is allowed as the expenditure is treated as capital.
Statutory renewals relief is given by virtue of Income Tax (Trading and Other Income) Act (ITTOIA) 2005, s68, which offers limited relief for replacement items such as cushions and other small consumable furnishings.
It is not possible to claim the renewals basis for items such as white goods.
LANDLORD’S ENERGY SAVINGS ALLOWANCE (LESA)
Ordinarily the cost of installing new insulation would be considered an improvement and therefore treated as a capital cost.
However, under the Landlord’s Energy Saving Allowance, the cost of certain energy-saving items in let residential property is an allowable deduction against the rent received, provided the expenditure is incurred before 6 April 2015.
Energy-saving items include:
- loft insulation
- cavity wall insulation
- solid wall insulation
- draught proofing
- hot-water system insulation
- floor insulation.
This is subject to a maximum of £1,500 per dwelling.
Expenditure may need to be apportioned, for example, where a landlord installs energy-saving items in a building that only partly comprises let residential property, or a building containing more than one dwelling.
In these circumstances, a just and reasonable apportionment of the expenditure must be made between all the properties which benefit from the energy-saving item.
Ordinarily, the cost of redecorating would be an allowable revenue expense.
However, if the work is undertaken as part of an improvement, the entire cost is treated as being capital, including the redecoration
Finance interest payable on loans (including incidental cost of financing) used to buy land or property, which is used in the rental business, or on loans to fund repairs, improvements or alterations, is deductible in computing the profits or losses of the rental business regardless of the security given for borrowed funds.
If a property is let for short periods in a tax year, or only part of it is let throughout a tax year (or both), the interest charged on a qualifying loan on that property has to be split between the rental business use and the private or non-business use.
The split is done in whatever way produces a fair and reasonable business deduction, taking account of both the proportion of business use and the length of business use.
The interest does not have to be split if the landlord is genuinely trying to let the property but it is empty because they have not been able to find a tenant.
In this case, the interest will meet the ‘wholly and exclusively’ test.
The cost for preparing rental accounts is an allowable expense.
However, the cost of completing the landlord tax return is not allowed as it is a private expenses
CHANGES FOR 2016 in the Finance Act 2016
Finance Bill 2016 repeals the wear and tear allowance and makes a new provision for a deduction for the replacement of furnishings.
The deduction will be available in calculating the profits of a property business which includes a dwelling-house.
The deduction is available for expenditure on furniture, furnishings, appliances (including white goods) and kitchenware, where the expenditure is on a replacement item provided for use in the dwelling.
The deduction given will be for the cost of a like-for-like, or nearest modern equivalent, replacement asset, plus any costs incurred in disposing of, or less any proceeds received for, the asset being replaced.
The deduction will be available for expenditure incurred on or after 1 April 2016 for corporation tax payers and 6 April 2016 for income tax payers.
This deduction will not be available for furnished holiday lettings because capital allowances will continue to be available for them.