We’ve noticed that some landlords forget that they actually run a business, particularly if they only have one other property and receive a reasonable stream of monthly rental. However, just like any business, there are claims you can make that will maximise your tax position and maximise your after tax profits. We are going to review these in this article.
The bottom line is simple, you are allowed to make certain expense claims associated with owning and operating a rental property. These are known as ‘Allowable Expenses’. These can be deducted from your business profits before your tax liability is calculated. The more expenses you claim, the lower your tax bill. One does need to be careful here as it’s easy for HMRC to scrutinise your claims. If HMRC has any reason to believe that you may be using expenses in a fraudulent manner, such as claiming expenses that are not truly related to running your business and therefore artificially lowering your tax liability.
So, understanding what you can and cannot claim is a great starting point in helping you revisit your expenses, making the most out of any deductions and maximising your rental income profits.
Understanding the ground rules – is it revenue or is it capital
As you might expect, HMRC are very good at creating rules that help distinguish whether any work you do on your rental property could be allowed as an expense. In this case one needs to consider if work you undertake is a capital investment or part of maintaining your revenue stream. Put another way, is the work you are doing on the property a repair or an improvement?
This is an area where landlords can make mistakes. It’s not unreasonable for the average landlord to think that refurbishing a rental property may be considered as an expense, so as to maintain revenue flow. HMRC are quite hot on this and you must think carefully as to how to apportion the expenses you incur.
When refurbishing, it’s critical you maintain accurate records showing what work constituted ‘repairs to the property’ and that which constituted ‘improvements’. For instance; painting and decorating would be an allowable expense as you are keeping the property in a rentable condition and probably honouring contractual obligations ensuring the property is fit for purpose. However, if as part of the work you decide to make alterations to the property’s configuration – perhaps make a room bigger, or add a loft room skylight, this would be classified as improvement work and therefore ‘capital’ and not an allowable expense.
If you are not able to show the split between repairs and improvement, HMRC will consider all work as capital and tax accordingly.
Capital expenses
Understanding what HMRC considers capital expenditure can help clarify what you can and cannot claim for.
When starting out for instance, it is typical for the owners to think that they could claim the cost of bringing a ‘distressed property’, probably purchased at a reduced rate, into a fit state for letting. This isn’t an allowable expense. You may however, be able to set this against capital gains allowances if you sell the property in the future. So, keep accurate records.
What is a capital expense?
If something is to be used by a business over a long period of time, they will most likely be capital expenses. For instance, where property is concerned:
- Make an addition to a property
- Improve or upgrade and existing part of the property
- Replace something with one of a higher specification
So, some expense examples that would not be allowed include:
- Extending the property
- Adding security system
- Replacing a bathroom suite with one of a higher specification
So, what can you legitimately claim for beyond the more obvious repair work?
Allowable property expenses
We arranged these in stages related to the scope of the expense.
Before you rent out a property
- Redecorating prior to a new tenant
- Replacing broken items, such as hot water systems, kitchen surfaces (as long as it’s not an improvement)
- Roof repairs
- Replacing items with their nearest modern equivalent provided the improvement is coincident to the repair.
- Replacement of items with a short useful life and of low value – soft furnishing, cutlery and crockery for instance.
- Replacement of fixtures and fittings. For instance baths, toilets, etc. just so long as they are like-for-like replacements and not improvements.
- Insurance policies for landlord, buildings and contents, public liability
- Legal fees, accountant fees
- Management and letting agent fees
- Direct costs related to advertising for new tenants, such as advertisement fees (creating and running them), telephone costs, etc.
While your property is let out
- Costs associated with garden maintenance, cleaners, etc.
- Utilities and council tax if you pay for these yourself and not the tenant
- General maintenance and repair
- Costs associated solely with running you car for business
- Fees you have to pay that are not passed on to the tenant, such as rent payments if you are subletting, ground rents and service charges.
- The interest element of any mortgage you pay on the property. This is not directly tax deductible for individuals. Instead 20% of the interest amount is allowed as a tax reducer. If the property is owned by a limited company, the full interest charge is corporation tax deductible.
What allowances are available to landlords?
Note that these are different from allowable expenses.
You have a choice; you can claim the “Property Allowance” and receive £1000 a year tax-free. However, if you claim this, you cannot then claim for your other expenses. It makes sense to use this allowance if your allowable expenses are less than £1,000.
When you rent out a residential property – a dwelling, you may be able to claim a deduction for the replacement of certain domestic items. This Income Tax relief is only available for expenses incurred from April 6 2016. It covers items such as:
- Movable furniture
- Soft furnishings and floor coverings
- White goods and other appliances
- Kitchenware
This relief can only be claimed if:
You’re letting out residential homes (dwellings)
You’re replacing an old no longer serviceable item for a new domestic one and it is only for the use of the lessee in this dwelling house and the old item is withdrawn from service and no longer available to the lessee.
You cannot have claimed Capital allowances on the expenditure
When can’t you claim this relief
- When the property is a furnished holiday let. Capital allowances will still apply though
- Rent-a-room schemes
- The costs of initial domestic items for the residential property under let
What happens if I have to buy an improved version of something?
Sometimes we have no choice but to replace something with a new and improved item. HMRC defines an improvement as:
- Not being the same or substantially the same as the old item
- Its functionality has changed – as often happens with new white goods
- It represents a material upgrade to the quality of an item – replacing. Plastic worktop with a granite one, for instance
In these circumstances you can only claim a deduction based on the cost of the old one. So for instance, if an improved replacement item costs £200 and an equivalent to the old one would have cost £150, then you can only claim for the £150.
When calculating the deduction, you should also take into account:
- The cost of the replacement item
- Any costs relating to buying it
- Disposal costs if any
Then you must deduct any income received from disposing of the item – for instance if you sold it for scrap.
In conclusion
It’s not always obvious what you can claim for and what you can’t claim for, or even how to claim, especially if you report your income through your SA100.
If you make a mistake and HMRC makes a challenge, the situation could become expensive as you may have to hire an accountant to help you.
Tax Agility has assisted many clients with their residential lettings businesses. So, it doesn’t matter if you’re running a lettings business or are an individual with a single property under let, we can help you identify your legitimate expenses, make the appropriate claims, ensure you take full advantage of any allowances, so as to maximise your rental profits. Helping individuals and small businesses maximise tax efficiency is at the heart of what we do – the clue is in our name – TaxAgility!
Call us today on 020 8108 0090 and find out if we can help your residential lettings business improve its bottom line!