In the current financial climate people are inevitably looking for ways to increase their household income. Many are doing this by renting out a spare bedroom.
The HMRC rent-a-room scheme, which was introduced in 1992, is an optional tax exemption scheme that lets people receive gross (income before expenses) tax-free income of £4,250 per annum from renting out spare rooms in their only or main home. The exemption is not restricted to homeowners, but of course those who are themselves renting their property need to check whether their lease allows them to take in a lodger.
Broadly, income tax relief under the rent-a-room scheme is available to anyone who lets furnished living accommodation in his or her main residence. A lodger will typically have a furnished bedroom and share the family rooms. More than one room in the home may be let provided that the rooms qualify for relief in their own right.
The rent may include provision for meals, cleaning and laundry, and so on, and the relief can cover income from bed and breakfast guests and payments from those requiring care. However, in such cases HMRC may treat the income as arising from a trade, in which case the normal income and expenditure rules connected with running a business will apply.
Where a married couple or civil partners let a room, the income will normally be treated as accruing equally between them. Where the letting amounts to a trade, the income will be assessable to income tax on the spouse or partner providing the services.
Accounting for Tax
The £4,250 annual tax allowance works out at around £80 per week and many lodgers nowadays pay more than this amount. For tax purposes, landlords who receive more than the annual exempt amount have two options available to them.
Under the first option, the landlord counts the first £4,250 in rent as the tax-free allowance and pays income tax on the remaining income. In this case, the landlord will only have to keep a record of the income received since no claim for any expenses will be made.
As an alternative, the landlord could treat renting the room as a normal rental business, working out a profit and loss account using the normal income and expenditure rules. In this case, the landlord must keep records of all income and any expenditure incurred in connection with renting out the room(s).
During the tax year Alan receives gross income from letting out a spare room of £5,000 but his expenses for that year were £6,000, resulting in a net loss for the year of £1,000. If he uses the first option above, he will be taxed on the excess of the gross income of £5,000 over the exemption limit of £4,250 leaving a taxable profit of £750. Clearly, it will be more beneficial for Alan to opt for the second option.
In most cases, the first option (known as the ‘alternative basis’) will be more advantageous, unless the landlord is running a substantial room renting business with high-paying lodgers.
In both cases, the landlord will need to maintain proper records and complete a self-assessment return each year. A claim for rent-a-room relief (where rents are £4,250 or less (or £2,125 if let jointly)) is made by putting an ‘X’ in box 4 of the UK Property supplementary pages of the self-assessment return. These pages can be downloaded from the HMRC website at http://www.hmrc.gov.uk/forms/sa105.pdf.
Tip - As a landlord, you have up to one year after the end of the tax year in which your income from renting out a room exceeded the £4,250 threshold, to decide which option to take. Consideration should therefore be given as to which route produces the lowest tax bill. It is possible to change the method of accounting for tax from year to year, as long as HMRC are notified within the statutory time limit.
Rent-a-room relief does not apply if the taxpayer also rents unfurnished rooms in the same property, in the same tax year. For example, where a furnished room is let to a lodger and an annexe is let unfurnished.
In addition, rent-a-room relief cannot be claimed where the property ceased to be the taxpayer’s home before the letting period began, or commenced to be the taxpayer’s accommodation after the letting ceased, even if the events occur during the same tax year. So the taxpayer and the lodger must occupy the property for at least part of the letting period each tax year.
Where an owner moves into a new property leaving the lodger in occupation, relief should be available until the end of the tax year.
Letting Whilst Overseas
Taxpayers who let rooms whilst they are working abroad, or who live in job-related accommodation, cannot claim rent-a-room relief unless the room was already let before they moved abroad (or into job-related accommodation). In such cases rent-a-room relief may apply for that tax year (and vice versa on return).
In short, the relief does not extend to the letting of rooms as office accommodation. Back in 1994, there was some suggestion in the professional press that relief could be available where a residence, or part of a residence, is used as an office or for other trade or business purposes (other than the business of providing furnished living accommodation) and sums are paid in respect of that use.
HMRC’s position is that such claims are inadmissible. In HMRC’s view, the words of the tax legislation do not allow such claims, and the legislation was never intended to give relief in such circumstances.
Rent-a-room relief applies to rooms let in a taxpayer’s UK main residence (and not a second home). It does not matter whether the property is owned or rented or if the claimant rents other property for their use in the UK or overseas. Residence is defined as any building or part of a building which is intended to be occupied as a separate residence, a caravan or houseboat.
If a building is temporarily divided into two or more parts occupied as separate residences, provided it was designed for permanent use as a single residence, it will still qualify for rent a room relief. A permanent alteration to create a self-contained apartment, will not qualify.
The capital gains tax principal private residence exemption is not normally affected where rooms qualifying for rent a room relief are let.
As stated above, taxpayers letting rooms are eligible for rent-a-room relief if the income does not exceed the qualifying annual limit (currently £4,250 per annum). Broadly, income includes the rent itself and any sums paid in respect of meals, goods and services provided in connection with the use of accommodation.
This will include, for example, cleaning and laundry services. The fact that such sums may be paid under a separate agreement is irrelevant if the goods or services supplied are connected with the use of the furnished accommodation. Rent from letting other non rent-a-room properties is not counted as income for this purpose.
The qualifying limit depends on the number of people entitled to the income from renting rooms.
- Where only one person is entitled to the income, the limit is £4,250;
- Where two people are jointly entitled to the income, each is entitled to relief of £2,125 (half the individual limit); and
- Where more than two people are jointly entitled to the income, each is entitled to relief of £2,125.
If the taxpayer moves during the year and lets rooms in both the old and new properties, the income must be aggregated.
Income Not Exceeding Qualifying Limit
Where the income from renting a room is less than the taxpayer’s qualifying limit, the chargeable profits are treated as nil. Losses cannot be claimed but a claim for rent a room relief does not prevent unrelieved losses from earlier years not subject to a claim for rent a room relief, from being carried forward to a later year.
Income Exceeding the Qualifying Limit
Where an individual’s income from letting a room is more than the qualifying limit, the chargeable profits are taxed in the normal way. However, an election can be made for an alternative basis of taxation to apply based on the rent-a-room qualifying limit.
Where only one room is let, the alternative basis taxes the excess of the income over the individual’s qualifying rent-a-room limit. No deduction is given for expenses, interest paid, losses or capital allowances. Whether such an election is beneficial depends on the deductions available.
George lets a room in his house for £100 per week. The expenses attributable to the income amount to £750 a year.
Calculated on a normal basis, the taxable profits are £4,450 (£5,200 – £750). On the alternative basis, the taxable profits are £950 (£5,200 – £4,250). George will therefore elect for the alternative basis to apply in writing by 31 January following the tax year (22 months after the end of the tax year). The election will continue to apply until it is withdrawn.
An election may be made for rent-a-room relief to be disapplied for a particular tax year. This could be advantageous where there are losses, or substantial capital allowances. Elections, relating only to the tax year concerned, must be made in writing by the first anniversary of 31 January following the year to which the claim relates (22 months after the end of the tax year).
By Sarah Laing
This article was first printed in Property Tax Insider in December 2010.