Cash Basis vs Accruals Basis
The majority of landlords prepare accounts using the default ‘cash basis’ where income is recognised when received and expenses when paid (providing that the expense is incurred ‘wholly and necessarily’ for the business). Although this basis is straightforward in calculation, the disadvantage is that some items of a ‘capital’ nature cannot be claimed such as a computer, office equipment, any item used in a residential rental property (excluding Furnished Holiday Lets) and, specifically, a car (although business mileage-based relief is available). However, using the alternative ‘accruals’ basis of assessment allows tax relief on such items. Accounts on this basis declare income when earned and expenses when billed rather than when paid. The ‘accrual’ basis must be used should rental income exceed £150,000 a year or the property business is run by a company. A landlord can choose which basis to use but, as ever with tax, which is best taxwise depends on the figures.
What Can You Claim?
Tax relief is permitted for the day to day running costs of the business which generally fall within two categories:
- Property costs – e.g. council tax, repairs, ground rent, legal fees, wages
- Business costs – the administrative costs of the property business, e.g. phone bills, stationery, postage, accountancy fees
There is no definitive list of what expenses are allowable for income tax purposes but a good place to start is the list on HMRC’s website, which includes all the ones you would expect to see such as house insurance, letting agent’s fees, water and general rates (where not already paid for by the tenant). Any allowable expenses incurred between tenants can be claimed, assuming that it is intended for the business to continue.
Other expenses not specifically itemised but claimable can include rent insurance, expenses related to landlord regulations (i.e. Gas Safety Certificates/checks, EPC’s, Smoke & Carbon Monoxide Alarms etc.), expenses incurred on eviction, software, cleaning services including end of tenancy cleaning, regular cleaning for Houses of Multiple Occupation and common areas when dealing with commercial lets.
Dual Purpose Expenses
In practice, some ‘dual purpose’-type expenses may also be permitted such as expenses incurred on running a car used partly for business and partly for private purposes, the business part being allowed. Two methods of calculation are possible – either claim 45p for the first 10,000 business miles incurred and 25p for any additional miles or work out the actual cost of running the car (car tax, insurance, repairs, petrol), recording the mileage of every property-related trip made in the tax year and also the total mileage, then claim the proportion of running costs relating to the business mileage. For most landlords the mileage rate is probably the most cost effective method to use as the motoring will probably be modest.
White Goods, Appliances and Furnishings
One area that can produce confusion is where the landlord purchases ‘white goods’. Increasingly landlords are obliged to purchase such items for tenants but for tax purposes the initial cost is deemed a ‘capital’ item. Only when such items are replaced can income tax relief can be claimed provided the item is a ‘like for like’ replacement. This rule applies to appliances, furnishings and even kitchenware provided the tenants use the items. Should the item be fixed or installed into the property (e.g. boilers, lifts, radiators, bathroom items, built-in wardrobes and cupboards), it is also capital. Only when such items are repaired or replaced can a claim be made under ‘repairs’. For example, if similar quality 10 unit kitchen is replaced with one having 12 units, then the cost of acquiring and installing the two extra units is a capital improvement, while the ten units are a ‘like-for-like’ repair and allowable against rental income.
Refurbishments – Are they a repair or an improvement?
Sometimes it can be difficult to ascertain whether an expense is capital or income, mainly when refurbishment of a property takes place. If the property is run down and dilapidated, then the cost of making it fit for rental may be regarded as capital. A ‘rule of thumb’ is that if the property was already being rented out or could be so, then any expenditure is deemed to be repairs. However, if you add something which was not there before then this will be an improvement and a capital cost. An example would be if you replace a bath with a shower cubicle, this would be capital. Just because the repairs are undertaken before the first letting does not mean that they are not allowable. If you lived in the property prior to letting, then work carried out before letting is maintenance due to private use rather than for rental purposes, so cannot be claimed.
Legal costs are another area for confusion. To be allowed as a revenue expense the cost must have been incurred in relation to a revenue item, such as the renewal of a lease if the lease is for less than 50 years (except for any proportion that relates to the payment of a premium on the renewal of a lease) or in connection with the first letting if it is for less than a year (including the cost of drawing up the lease, agents’ and surveyors’ fees and commission). Costs incurred on rent arbitration or eviction of an unsatisfactory tenant so the property can be re-let, are also income tax deductible. Where a lender charges a penalty on the early repayment of a loan, HMRC accepts this as a cost relating to the loan itself and therefore deductible as an expense against income.
Other legal costs will be treated as capital expenditure if they relate to capital items, e.g. relating to the purchase or sale of the property or in connection with the first letting or subletting for more than one year (including the cost of drawing up the lease, agents’ and surveyors’ fees and commission).
A major expense for any landlord will be the mortgage interest. Tax relief for finance costs (including mortgage interest) relating to residential properties is given as a restricted tax deduction of 20% of the interest paid after deducting all other expenses and losses brought forward. In comparison, relief for commercial and furnished holiday lets is given as a full deduction from the rental income received.
Many landlords mistakenly believe that if they have a repayment mortgage the whole monthly payment is deductible. I am afraid it is only the interest element that is allowable.
Can You Claim For Your Own Time Spent in Managing The Rental Property?
Unfortunately, landlords cannot claim their own time for working on their business. If you carry out a significant amount of administration work on the properties, then you may be able to claim a flat rate allowance. For small landlords, it will be difficult to justify a use of office claim because you would need to work at least 25 hours per month to make the minimum claim. If you work from home for your employer because of the Covid pandemic or because your employer requires you to work from home, HMRC allows a flat rate of £6 per week. A claim based on a reasonable proportion of the household bills can be made as a second option. Total the home costs including mortgage interest and utility bills then are then divided by the number of rooms in the home to work out the claim.
For a full list of expenses that you can claim download our free Property Tax Guide.
If you have a pressing question and need an answer quickly contact us on 01902 711370 or send your query to us through the contact page.