HMRC have recently published a series of case studies which aim to help landlords avoid common mistakes when working out and reporting income and profit from renting out property. Some of the situations covered by the case studies are explored below. The case studies are taken from HMRC’s guidance.
If you increase the mortgage on a buy-to-let property, the interest on the additional loan is deductible as a revenue expense, but only on total borrowings up to the capital value of the property when it was brought into the letting business. Interest on borrowings in excess of the value of the property when brought into the letting business is not deductible.
Example 1: Mortgage increase
You purchased a buy-to-let property for £120,000 with a mortgage of £90,000 and let it to a tenant straight away.
Three years later the property is valued at £150,000 and you increase your mortgage on the property to £115,000. All of the interest on the mortgage can still be claimed as a revenue expense, as the loan doesn’t exceed the initial £120,000 value of the property when it was introduced to your letting business.
If you increased the mortgage to £125,000, the interest payable on the additional £5,000 is not tax deductible and cannot be claimed as a revenue expense.
The loan does not have to be secured on the rented property for relief to be available.
The way in which relief for interest is given is changing from 6 April 2017, gradually moving from a tax deduction to a basic rate income tax reduction.
Expenses – ‘Wholly and exclusively’ rule
Expenses can be deducted from rental income if they are incurred ‘wholly and exclusively’ for the property rental business. If an expense was not incurred for the purposes of the property rental business in any way, it cannot be set against the rental income.
Example 2: Allowable and non-allowable expenses
If you buy a new vacuum cleaner for your own home, and also use it to clean your rental property between tenants, you can’t claim the cost of the vacuum cleaner as an expense against your rental income.
However, you could claim the cost of any cleaning products you bought specifically for cleaning the rental property.
Claiming part expenses
Sometimes a cost may be incurred which is not `wholly and exclusively’ for the purposes of the property rental business, although part of the cost is. Where a definite part or proportion of an expenses is incurred wholly and exclusively for the purposes of the property business, a deduction can be claimed for that part or proportion.
Example 3: Partial relief for expenditure
Tom has an investment property, and he decides to replace the tiles in the bathroom. His local tile shop has an offer of 12 square metres of tiles for £240.
He only needs 8 square metres for the bathroom, but the offer is excellent value for the money and too good to miss. He therefore purchases the tiles.
He decides to use the extra 4 square metres of tiles for his own house.
This means that the entire cost has not been incurred wholly and exclusively for the rental property.
However, a portion of the cost - two thirds, in fact - has been incurred wholly and exclusively for the property.
He can therefore claim £160 (i.e. two thirds of £240) against his rental income.
Typical maintenance and repair costs
There are typical maintenance and repair costs that a landlord is likely to incur, and these can be claimed against rental income. The list includes:
- repairing water or gas leaks and burst pipes;
- repairing electrical faults;
- replacing broken windows, doors, gutters and roof slates and tiles;
- repairing internal or external walls, roofs and doors;
- repainting and decorating (but not improving the property) to restore it to its original condition;
- treating damp or rot;
- repointing and stone cleaning;
- hiring equipment to carry out necessary repair work; and
- replacing existing fixtures and fittings, such as radiators, boilers, water tanks, bathroom suites and kitchens (but not electrical appliances).
Example 4: Water damage repairs
John is informed by his tenants that water is leaking from the upstairs bathroom into the downstairs living room. He calls a plumber to repair the damaged bathroom water pipe and also hires a painter/decorator to re-decorate the damaged ceiling.
The entire cost of the work is £300 and it can be claimed against the rental income. The painting and decorating was done to restore the damaged ceiling, not to improve it.
Don’t forget to deduct the cost of repairs to the property when working out the rental profit.
Replacing domestic items
A deduction is available where domestic items are replaced. The amount of the deduction is the cost of the replacement item (on a like-for-like basis) plus any cost of disposing of the old item, less any proceeds received from the sale of the old item.
Example 5: Replacing a bed
David has replaced a single, wooden framed bed in his rental property with a new double divan bed. The new double bed is an improvement on the old bed and David paid £500 for it, which is significantly more than the £150 it would have cost if he had replaced the old bed with a new equivalent wooden framed bed. Therefore David cannot claim more than £150 of the purchase cost as a deduction. David also paid an additional £20 to have the new bed delivered, but managed to sell the old bed online for £30.
David needs to work out how much he can claim as a deduction:
Cost of new replacement item (limited to the cost of an equivalent new item) £150
Plus any costs associated with buying the new replacement item
(in this case delivery charges) £20
Minus any amounts received on disposal of the old item (in this case selling
the old bed) £30
Amount deductible under replacement of domestic items relief £140
More than one property
Where a landlord rents out more than one property, the income and expenditure from all of the properties are combined to determine the overall profit or loss.
Example 6: Profits and losses
Carol has five properties in the UK. The following rental income is received and expenses incurred in relation to each of the properties in a single tax year.
Property Rental income Expenses Profit/(loss)
1 £7,000 £5,000 £2,000
2 £12,000 £6,000 £6,000
3 £4,000 £5,500 (£1,500)
4 £2,000 £3,000 (£1,000)
5 £10,000 £5,000 £5,000
Total £35,000 £24,500 £10,500
Properties 3 and 4 made a loss in the year. However, the rental business is treated as a whole. Relief for these losses is given automatically against the profits made by properties 1, 2 and 5. The rental business as a whole makes a profit of £10,500 and Carol will pay tax on this total profit. Carol does not need to claim relief for the losses on individual properties as all the properties are combined to form a single property business.’
The same approach applies if the business as a whole makes a loss.
Losses can be carried forward and set against future profits from the same property rental business.
Where a property is let on terms that are not commercial, for example at a reduced rent to a friend, expenses can only be deducted up to the value of the rent.
Example 7: Property let for reduced rent
John lets his flat to his brother. The commercial rent for the flat is £600 per month, but John only charges his brother £300 per month, which comes to £3,600 for the year.
During the same year, John’s expenses for the flat were £4,000 and so were more than the rent received.
John can deduct expenses from his rental income, but only up to the value of the rent he received, which is £3,600.
This reduces John’s profit to nil.
The £400 expenses that are left can’t be carried forward for use against rental income in future years, and can’t be used against any rental income from other rental properties.
If John’s brother had lived in the flat rent-free, then John would not be able to claim any expenses at all for this property.
Landlords should take a look at HMRC’s guidance at www.gov.uk/guidance/income-tax-when-you-rent-out-a-property-case-studies to ensure that they do not make common mistakes.
This article was first printed in Property Tax Insider in January 2017.