Tax Aspects of Property Investment
Income arising from land and buildings is generally treated as investment income unless it is from furnished holiday lettings or from property development or provision of services such as hotels and guest houses, in which case it would be classified as trading income.
From an accounting and tax point of view, all rental income (except furnished holiday lettings) is treated together as from one property letting business, regardless of the terms of letting. Profits and losses are calculated using the same general accounting rules as for trading, including accruals to cover the timing differences of rent or expenses in advance or arrears. A cash basis is allowable for total annual rents under £15,000.
Allowable expenses
Expenses allowable in calculating income include basic rate tax relief for finance costs in connection with the interest incurred on loans used towards the purchase of the property (adjusted for any part private use), business rates or council tax, rent payable to a higher landlord, insurance and management expenses including advertising for tenants, and maintenance, repairs and redecorations. Management expenses can also include costs of travelling exclusively for property letting purposes.
Expenses on improving the property (such as extensions or installing central heating) and those which were necessary to bring newly acquired property to a state where it could actually be brought into use all form part of the capital cost of the property.
Allowances for equipment
In general it is not possible to claim capital allowances for plant and machinery in a dwelling house. An allowance (now under legislation) is available to cover the wear and tear on items such as suites, beds, carpets, curtains, linen, crockery, cutlery, cookers, washing machines and dishwashers (excluding items such as council tax and water rates which would normally be payable by the tenant). In addition to this allowance it is also possible to claim a deduction for the cost of renewal of fixtures such as baths, washbasins and toilets.
The former concessionary renewals basis has been withdrawn with effect from 6 April 2013.
For commercial properties, capital allowances may be claimed in respect of plant and machinery supplied by the landlord. The allowances are calculated in the same way as for trades, and are deducted as an expense.
There are new rules about relief for finance costs and relief for replacing furnishings [see ‘Recent changes affecting landlords of residential properties’].
Rent a Room relief
Owner occupiers and tenants who let furnished rooms in their only or main residence may claim rent-a-room relief. This is available both for Schedule A businesses and where substantial services are also provided, for instance guest houses and bed and breakfast businesses where the rent would be chargeable as trading income. No tax is payable for gross annual rents (for accommodation and related goods and services) up to £7,500 (£3,750 each for a couple) from 6 April 2016. Where rents exceed £7,500 from 6 April 2016 you can choose to pay tax on the excess, or on the total rent less expenses in the normal way.
Furnished holiday lettings
Property letting businesses which comply with the relevant conditions can qualify for some very important tax concessions. Furnished holiday lettings are treated for tax purposes as if they were trades. Unlike other domestic lettings, the expenses can include capital allowances on furniture and kitchen equipment. The income counts as relevant earnings for pension contribution purposes, and there are other advantages relating to the disposal of such properties (see below).
Other considerations
Where there is mixed use of property, business rates may well be payable as well as council tax, unless the business use does not materially detract from the private use. Non-domestic properties, such as commercial premises and boarding houses, are in any event subject to business rates. Provision of bed and breakfast in your own house is not caught if there are no more than six guests. Staff accommodation is counted as domestic and therefore subject to council tax.
Value Added Tax on land and buildings is a complicated area. Generally sales of commercial buildings less than three years old are standard rated, sales of new residential properties are zero rated and most other sales or leases are exempt. The VAT provisions on property letting are particularly complex.
Until 1 April 2016, there is no charge to Stamp Duty Land Tax (SDLT) if residential property is purchased for £125,000 or less, or on non-residential property for £150,000 or less. Property which is not exempt is charged at a rate of 0%, 2%, 5%, 10% or 12% as appropriate. A 15% rate applies to residential properties over £2 million, purchased by certain non-natural persons. However, from 1 April 2016, higher rates of SDLT will be charged on purchases of additional residential properties (above £40,000), such as buy-to-let properties and second homes. The higher rates will be three percentage points above the current SDLT rates.
Special incentives
Initial allowances of up to 100% are available for expenditure by property owners and occupiers on the renovation of empty or underused space above qualifying shops and other commercial premises to provide residential flats for leases of no more than five years.
A maximum 100% initial allowance is available for qualifying business premises renovation. Writing down allowance of 25% (straight line basis) applies to expenditure where initial allowance is not claimed.
Disposal of properties
If the purchase and sale of properties amounts to a trade then, of course, property disposals will be taxed as income in the normal way.
In all other cases, disposals will be subject to the normal rules for the calculation of capital gains. Most let properties will not qualify for Entrepreneurs’ Relief; however, furnished holiday lettings count as business assets and so the relief will be available.
The situation may be complicated where a principal private residence has been let other than during the last eighteen months of ownership or during a period of allowable absence. In these circumstances, the associated lettings relief of up to £40,000 could be brought into play.
Furnished holiday lettings may qualify for rollover relief or gifts relief. In some circumstances they may also trigger inheritance tax business property relief, in which case they would pass free of any inheritance tax charge.
Whilst some of the principles of property taxation may seem relatively straightforward, there are many traps for the unwary, and professional help is definitely advisable. Please contact us for more information.