Sarah Bradford explains how the rent-a-room scheme can be used to generate tax-free rental income from letting a room in one’s main home.
The rent-a-room scheme allows owner-occupiers and tenants to earn rental income tax-free up to their rent-a-room limit by letting one or more spare rooms in their home. If the rental income received does not exceed the permitted amount, the income does not need to be reported to HMRC.
You can still benefit from the scheme if your rental income exceeds the limit by claiming rent-a-room relief rather than by deducting actual expenses.
When the scheme can be used
You can use the scheme if you let one or more furnished rooms to a lodger or lodgers. The rooms must be in the property you occupy as your main home, either as an owner occupier or a tenant (but if you are a tenant, check with the landlord that you are able to sublet a room). You can also benefit from the scheme if your letting is classed as a trade; for example, if you run a guest house or a bed and breakfast business, or if you provide your lodger with services such as cleaning and meals.
However, the scheme cannot be used if the rooms let are not in your main home or are let unfurnished. Further, the scheme does not apply if you let rooms in your main home while you are living elsewhere, or are abroad. It is only available in respect of rooms let for residential use and does not apply if you let a room to be used for the purposes of a business or as an office. However, the benefit of the scheme is not lost if the lodger works in your home in the evenings or at the weekend or you let a room to a student and provide study facilities (for example, a desk and chair).
Rent-a-room limit
Where only one person benefits from the rental income, they do not have to pay tax on their rental profits if their gross rental income (i.e., before deducting expenses) is not more than £7,500 a year. Where two or more people benefit from the rental income, their profits are tax-free if their share of the gross rental income is not more than £3,750 a year.
The limit of £3,750 per person applies regardless of how many people benefit from the rental income; so if four people share a home, each person can benefit from tax-free profits as long as their share of the gross rental receipts does not exceed £3,750 – it does not matter that the combined total of £15,000 is more than the individual limit of £7,500. The limits apply per person rather than per property.
Taxpayers can also benefit from the scheme where their share of gross rental income exceeds their rent-a-room limit.
Gross receipts are less than the rent-a-room limit
The scheme is very simple where gross receipts are less than taxpayer’s own rent-a-room limit, and they do not make a loss. Where this is the case, they can enjoy their rental profits tax-free without any need to report them to HMRC.
Example 1: Rental income below rent-a-room limit
Louise lets out a furnished spare room in her own home to a lodger. She continues to live in the property. She receives rent of £500 a month – a total of £6,000 a year. Her expenses are £450 a year.
As her gross rental income of £6,000 is less than her rent-a-room limit of £7,500, she can enjoy her rental profit of £5,550 tax-free, and does not need to report it to HMRC.
Claiming rent-a-room relief is not beneficial where a loss is made, as the benefit of that loss is lost. It is better to work out the loss in the usual way and return the income and expenses on your tax return, so that the loss is available to set against future taxable rental receipts if need be. You must elect for the relief not to apply as it is given automatically where gross rental receipts are below the rent-a-room limit. This must be done by the first anniversary of the normal self-assessment filing date (i.e., by 31 January 2027 for the tax year 2024/25).
Gross rental receipts exceed the rent-a-room limit
Where gross rental receipts from letting a furnished room in your own home exceed the rent-a-room limit, you have a choice of how to work out your profit and can choose the method that is most beneficial (i.e., the one that gives the lowest taxable profit).
Under Method A, you simply work out your profit in the usual way and deduct expenses from your gross rental income. Alternatively, you can take advantage of the rent-a-room scheme and use Method B to work out your profits. Where this route is taken, your taxable profit is found by deducting your rent-a-room limit of £7,500 or £3,750 (as applicable) from your gross rental receipts.
Method A is beneficial where your expenses exceed your rent-a-room limit; and Method B is beneficial where actual expenses are less than the rent-a-room limit.
Example 2: Rental income above rent-a-room limit
Jake lets out a room in his London flat for £800 a month, providing him with gross rental income of £9,600 a year. He incurs expenses of £1,200 a year.
Under Method A, his rental profit is £8,400. However, if he opts to use Method B, his rental profit is only £2,100 (i.e., £9,600 - £7,500).
Method B is clearly beneficial, as it reduces his taxable profits by £6,300. If Jake is a higher rate taxpayer, this will save him £2,520 in tax.
Electing for Method B
HMRC will automatically use Method A to calculate the rental profit, unless the taxpayer has informed them that they want Method B to apply. This can be done by ticking the relevant box on the property pages of the self-assessment tax return and must be done within the time limit. This is one year from 31 January after the end of the tax year (i.e., the first anniversary of the normal self-assessment filing date).
For example, a taxpayer must elect by 31 January 2027 if they wish to switch to Method B for 2024/25.
Once an election has been made, it remains in place for subsequent years unless it is withdrawn.
Review each year
The method that gives the best result will not necessarily be the same each year. Consequently, you should check each year whether Method A or Method B is most beneficial. You can change which method you use from year to year as long as you tell HMRC within the time limit.
If you are using Method A and want to swap to Method B, you will need to elect for Method B to apply within one year of the normal self-assessment filing date. If you have previously made an election to use Method B, this will remain in place until you withdraw that election. This must also be done by the first anniversary of the normal self-assessment deadline.
For example, if you used Method A for 2023/24 and want to use Method B for 2024/25, you will need to make the election by 31 January 2027. Likewise, if you had a Method B election in place for 2023/24 and wish to revert to Method A for 2024/25, you must withdraw the election by 31 January 2027.
Moving home
If you move home during a tax year and let out one or more furnished rooms in both your old home and your new home, it is important to note that your rent-a-room limit applies per tax year rather than per property.
Consequently, you need to add together your receipts in the tax year from each property to see if they exceed your rent-a-room limit and whether you need to report the income to HMRC.
Capital gains tax
Earning rental income under the rent-a-room scheme does not compromise the availability of principal private residence relief for capital gains tax purposes.
Principal private residence relief is not restricted for any period for which the taxpayer took account of rent-a-room relief, and it is not necessary to claim lettings relief.
Practical tip
Consider letting out a spare room in your home to earn tax-free rental income by taking advantage of the rent-a-room scheme.
