As UK property accountants and tax advisers, we are regularly in discussions with our clients as to the correct treatment of expenditure relating to property letting income. Expenditure will be classified as either Capital or Revenue.
Revenue expenditure items are typically the day-to-day expenses, incurred in the normal course of running and maintaining a property to generate rental income. The expenses are normally recurring and can be deducted from the rental income to calculate the taxable profit.
Examples of revenue expenditure will include:
Repairs and maintenance, letting agent, insurance premiums, utility bills, advertising costs for finding tenants.
Capital expenditure normally involves costs that are incurred to acquire, improve, or extend the life of a property. These expenses are considered investments in the property’s long-term value and are not fully deductible against rental income for tax purposes. Instead, they may be eligible for capital allowances e.g., furnished holiday lettings, or may reduce the capital gains tax liability when the property is sold.
Examples of capital expenditure will include:
Major renovations, structural improvements, extensions, and significant upgrades that enhance the overall value or extend the useful life of the property.
Building extensions or additions that increase the overall size and value of the property.
Significant changes to the property’s structure, such as removing or adding walls, changing the layout, or making structural enhancements.
Installing new fixtures, fittings, or integral features that are not considered routine replacements. This may include a new central heating system, a new kitchen, or a new bathroom.
Legal and professional fees associated with the acquisition of the property, such as conveyancing fees and surveyor’s fees.
Significant landscaping or external improvements that enhance the property’s appearance and value.
There are situations where work is carried out on property and the lines between Capital and Revenue are not completely clear. Ove the years there have been several appeals heard as to where the lines should be drawn. There is an alternative to studying the fine detail of decided tax appeals and that is a reference to HMRC manuals. Whilst HMRC manuals are not legally binding they can on occasion provide useful guidance on their view. On the subject of Capital or Revenue or repair v improvement, the Property Income Manual does provide insight as to how HRMC might interpret expenditure. Below is an extract from advice on how to identify improvement and therefore capital expenditure:
It is largely a question of fact and degree in each case whether expenditure on a property leads to an improvement.
Sometimes the improvement may be so small as to count as incidental to a repair. In the absence of other capital indications, the entire cost is then revenue expenditure.
Problems can arise when the customer does work on an old asset. A repair or replacement of a part of a building using modern materials may give an apparent element of improvement because of the greater durability, superior qualities, and so forth of the new material. However, the cost normally remains revenue expenditure where any improvement arises only because the customer uses new materials that are broadly equivalent to the old materials.
For example, the following are usually revenue expenses in the absence of any other capital indications. The cost of replacing:
- wooden beams with steel girders, and
- lead pipes with copper or plastic pipes.
There is likely to be capital expenditure if, say, the steel girders were designed to take heavier loads so that the building could take larger machines after the work was done. The same is true if the new pipes are designed to take greater pressure or heat.
However, there is usually no improvement if trivial increases in performance or capacity arise solely from the replacement of old materials with newer but broadly equivalent materials. For example, the replacement of pipes or storage tanks of imperial measure with the closest metric equivalent may result in slightly increased diameter or capacity but the cost is still revenue expenditure.
Where a significant improvement arises from the change of materials, the whole of the cost is capital expenditure. This includes things like redecoration after the main work has been done (redecoration would ordinarily be a revenue expense). The entire cost is capital expenditure, including the expense of making good any damage to decorations.
Similarly, alterations due to advancements in technology are generally treated as an allowable repair rather than an improvement if the functionality and character of the asset is broadly the same. For example, when single glazing is replaced with double glazing.
Whilst the above extract is indeed informative there are a number of cases we see where uncertainty still exists as to the correct treatment. We can help you with the potential treatment of expenditure on let property, simply contact us on 01902 711370 or email enquiries@uklandlordtax.co.uk.
