Lee Sharpe concludes his consideration of the tax aspects of a house in multiple occupation (HMO) conversion.
In this final instalment of the case study from previous articles in this series, I pick up the thread of ‘capital versus revenue’ expenditure, firstly by developing the capital allowances issues, and then looking at rooves (or roofs).
4. Mains consumer unit and new boiler
In line with the requirement for fire doors at (3) in Part 2, HMO licensing may well require that the mains consumer unit has a higher specification than an ordinary unit for a private homeowner. It follows that this would be an improvement, not a repair, so it must be capital. However, it should, in turn, qualify for capital allowances, assuming it is (as usual) located in a ‘common part’ (see Part 2) of the building (typically the entrance hall or similar), for ready access by all tenants.
Typically, the new boiler will deliberately have a higher designated output because of the increased occupation (rather than ‘by accident’, thanks to advances in technology), so it will be a capital expense. The original boiler may have been in a communal area, such as the kitchen. But, again, Yasmin will have ensured it is now removed from living spaces and housed in a common part of the property, such as a vestibule to the entrance hall. Here again, we are relying on the judge’s decision in Tevfik v HMRC [2019] UKFTT 0600 (TC), which is at odds with HMRC’s published guidance, as noted earlier in Part 2.
5. Fire alarm and video entry systems
These will again be improvements, not found in a standard private home. Both of these systems will likely be distributed throughout the building and include parts located inside tenants’ individual rooms, etc. Where they are located in the common parts, they should again qualify for capital allowances.
I have assumed here that the alarm system central apparatus (panels) in common parts, such as hall and landing, will sway towards more being eligible than not, but the balance of costs tips more towards the non-qualifying dwelling parts for the security systems.
6. Additional thermal or acoustic insulation
Additional insulation must be an improvement. Thermal insulation is specifically eligible for capital allowances (CAA 2001, s 28) elsewhere than in dwellings; here, it may be that there is some thermal insulation to the common parts that is potentially eligible, but my analysis ignores the modest adjustment.
The fact that the same insulation may serve both to prevent heat loss and noise transmission is not normally a problem, as long as thermal insulation was a main purpose of the expenditure (see HMRC’s Capital Allowances Manual at CA22220; strictly, noise insulation could qualify anyway, in some commercial scenarios).
7. Loose furniture and carpets (also replacement free-standing white goods)
These items are not part of the building, so given we are replacing ‘entire assets’, they must be capital (see Part 2). I have assumed that some of the expenditure incurred will be eligible for replacement domestic items relief as it replaces items already in the property – carpets, furniture, white goods in the ‘old’ kitchen, etc., that Yasmin has specifically paid for. But new furniture for the extra bedrooms cannot be a replacement, even if they are free-standing items in dwelling areas.
The £1,000 claim for capital allowances reflects the costs of carpets in common parts of the building, such as hallway and landing. Replacement domestic items relief is available only for assets in a dwelling, while carpets outside of dwellings are potentially eligible for capital allowances. I have in the past seen HMRC argue that the cost of renewing items was deductible only when incurred after the property letting had started, but it is not a point I have seen taken recently.
Where flooring is fixed (e.g., in the ‘wet’ rooms), it may be more appropriate to treat along the lines of whether the flooring is a repair to the entirety of the property, or a capital improvement.
8. Apportioning redecorating costs
As per Part 1, some apportionment of cost would be appropriate to reflect the parts of the overall works that involve capital improvements, such as new internal walls, vestibules, etc.
However, if there were no such structural or capital work, then redecorating could be fully deductible against rental profits.
9. Balnakeil baloney!
In Part 1, I covered HMRC’s old Tax Bulletin TB59, which was generally considered quite permissive, logical and useful. Another part of the TB59 article states:
“’Repair’ means the restoration of an asset by replacing subsidiary parts of the whole asset. An example is the cost of replacing roof tiles blown off by a storm. There won’t be a repair if a significant improvement of the asset beyond its original condition results – that will be capital expenditure. For instance, there will be a capital improvement if the taxpayer takes off the roof and builds on another storey.”
However, in Balnakeil v HMRC [2021] UKFTT 0193 (TC), the judge decided that replacing the roof of a ‘listed’ 18th Century farmhouse (using traditional methods and materials) as a major component of a project running to circa £1m amounted to capital expenditure because, while replacing a few roof tiles amounted to a repair, the roof was a separate asset (an ‘entirety’ in its own right), so replacing the whole of the roof must be capital:
“While maintenance expenditure for replacing missing or broken slates is undoubtedly revenue, when the roof is completely overhauled and becomes a replacement roof, expenditure is capital.”
The judge also quoted Lawrie v CIR [1952] 34 TC 20 in support of their assessment, which is surprising because (according to my version of the report of the hearing) at Scotland’s Court of Session, the Lords unanimously agreed that the premises as a whole comprised ‘the entirety’, not the roof alone. In other words, ‘the entirety’ is the building, not just the roof, and TB59 rules, OK?
10. Solar panels and apportioning capital allowances
HMRC’s position on capital allowances on solar panels in relation to dwellings is set out at CA20020, that with regard to CAA 2001, s 35 and the prohibition on plant, etc., ‘for use in a dwelling’:
“The plant or machinery doesn’t necessarily have to be located in a dwelling-house in order to be ‘for use in’ it. For example, if a landlord installs ground-mounted solar panels in the garden of a house he lets and the electricity generated will be used in that house, the solar panels will not qualify for PMAs…A lift or central heating system serving the common parts of a building which contains two or more dwelling-houses will not comprise part of any dwelling-house…[so should be claimable, but] a central heating system serving the whole of the building containing two or more dwelling-houses should be apportioned between the common parts [allowable], and the residential flats or individual dwelling-houses [not allowable].”
In Part 2, I discussed that HMRC believes an HMO is merely a single dwelling, but noted that Tevfik v HMRC [2019] UKFTT 0600 (TC) disagreed. Moreover, in Yasmin’s HMO we have two storeys that are separately capable of providing the facilities for ‘day-to-day’ private domestic existence, so even on HMRC’s terms, it could be argued that each storey comprises separate dwellings.
Moreover, I would argue that a boiler (4) or security system (5) is no more ‘used in a dwelling’ than is a lift (again, Tevfik found that mains, gas or electrical services, and security or communications systems are likewise not part of a dwelling).
Conclusion – And caveats
Happily, I have concluded that most of Yasmin’s expenditure should be deductible against her property business in some form or another (NB. the tax analysis of the figures in the case study is meant to convey a sense of the factors involved rather than how much will actually be deductible).
I believe it may be arguable that solar panels, boilers, fire alarms and similar systems are eligible for capital allowances if located in the common parts of an HMO comprising more than one dwelling, without necessarily needing to be apportioned (or even fully disallowed) as HMRC would like.
But on identifying aspects to which HMRC may object, it is essential the taxpayer seeks appropriate advice based on the facts relevant to the particular property – and ensures any areas of uncertainty are appropriately disclosed in their tax return so HMRC is fully aware of the nature of the claim.
