Where more than one property is rented out, the letting of all the properties is
treated as a single business, which allows a loss made on one property in a year
to be effectively set against profits made on others. No distinction is made for
these purposes between property let unfurnished and furnished, except for the
special rules which apply to furnished holiday lettings (see overleaf).

Make sure record keeping is good
Accounts should be prepared for the business in accordance with generally
accepted accounting principles, although in most cases this should simply
mean making sure that all rental receipts have been recorded and only expenditure
of a revenue nature has been deducted in arriving at profits.

Receipts
Rents should be included on the basis of the sum actually due for the tax year.
This means that any rent paid in advance that relates to a period after the end of
the tax year should be brought into account not when it is received but in the
following tax year. If you exclude such a receipt in year 1 make sure you remember
to pick it up when you prepare your figures for year 2.

Expenses
You can claim expenses which are revenue in nature. Capital items cannot be
claimed directly against income although some other relief may be available. You
must also show that the expense is incurred ‘wholly and exclusively’ for the
purpose of the letting business. If an expense has a personal element, it is
generally apportioned, with only the business element allowed as a deduction.

Typical expenses that can be claimed will include:

• advertising for tenants (but not for sale)
• agents’ fees in relation to the letting but not the purchase or sale
• expenditure on maintaining common areas of a building
• fees in respect of finance arrangements
• interest on borrowing to fund the purchase (don’t simply claim the total sum payable to the lender in the year as this will probably include some capital repayment as well)
• expenditure on various forms of insulation (ie loft) can be claimed up to
  1 April 2015 (there are some restrictions on this so you need to
  check carefully)
• any expenditure on services such as gardening or cleaning that you agree
  to provide.

Expenditure on the building
There may be a particular issue in dealing with expenditure on the fabric of the
property. A repair can be deducted from income but where there is a clear element
of improvement that takes the property beyond its original condition, then the
repair will be regarded as capital and cannot be claimed against income.

Common items of repair that can usually be claimed will include:

• exterior and interior painting and decorating
• repointing brickwork
• damp and rot treatment
• mending broken windows, doors, furniture and equipment such as cookers
• replacing roof tiles, flashing and gutters.

Where expenditure is clearly of a capital nature and results in an improvement to
the property, it may be possible to claim the cost of it in calculating the capital
gain when the property is sold. Improvement expenditure is deductible against
the gain, provided it is still reflected in the state of the property at the time of
the disposal.

Expenditure on furniture and fittings
The capital allowance rules that give some deduction for plant and machinery
expenditure do not generally apply to the rental of residential property.

Where a property is let on a furnished basis there is an optional allowance
towards the cost of furniture. HM Revenue & Customs (HMRC) allow a 10%
deduction of the net rents to cover the wear and tear on furnishings such as
carpets, beds, settees etc. Net rents means the rental income less certain
costs incurred by you as landlord but which are normally incurred by the tenant -
essentially council tax and water and sewage rates. There is no requirement to
demonstrate actual expenditure on the replacement of these items.

As an alternative, where the property is let furnished, the landlord can claim a
renewals allowance when furniture and fixtures such as baths etc are replaced.
The allowance cannot cover the original cost of the item, nor can it include any
improvement element in the replacement. This latter relief is also available on
fixtures where a property is let unfurnished.

Capital gains on the sale of the property
When the property is sold there may be a liability to capital gains tax (CGT) on the
disposal. The gain is calculated by deducting from the sale proceeds:

• the original cost of purchase
• the incidental costs of purchase and sale such as legal costs and estate
  agents’ fees
• any improvement expenditure which is still reflected in the state of
  the property.

Where the property that is being sold has also qualified at some time during the
ownership of the vendor as their only or main residence, part of the gain may be
exempt. In addition a letting relief of up to £40,000 may be claimable. Note that
this is generally available to anyone with a share in the property meaning a
couple, even if married, could potentially qualify for relief up to £80,000.

Any gains above the annual exemption which is currently £10,100 will attract
CGT at a rate of 18% (subject to any Budget changes on 22 June 2010).

The Labour government had announced that these tax rules would be repealed
generally from the 2010/11 tax year but the legislation was not passed before the
General Election got underway.

Comment
Although the outcome of the election is now known, uncertainty remains as to
which aspects of taxation policy will prevail and specifically the eventual treatment
of this category of letting. The continued delay in legislating the repeal proposals
means there are two key issues:

• whether any change can be operative for 2010/11 and
• whether the changes will go ahead as currently proposed.

The coalition government may amend the proposals or even scrap them altogether
and as this would inevitably lead to a further time delay before such changes are
introduced into tax law, implementation for this current tax year 2010/11 looks less
llikely. It will be essential to monitor developments in this area so please
contact us for any new announcements before considering key transactions.

In the meantime, the current rules in force are detailed below.

What are the conditions for special treatment?
The rules apply to the commercial letting of FHL accommodation in the European
Economic Area (EEA). This means that letting simply to family members or friends
will not qualify unless they pay a commercial rent. In order to qualify the property
must be:

• available for holiday letting to the public on a commercial basis for 140
  days or more, and
• let commercially for 70 days or more, and
• not occupied for more than 31 days by the same person in any period
  of seven months.

The period by reference to which those limits must be considered will normally
be the tax year. Special rules apply at the start and end of lettings.

If you own more than one FHL, you can claim to calculate the 140 and 70 day limits,
based on the average for all the properties you own, in order to satisfy the test.

• A qualifying loss on FHL can generally be set against other income
  (including non property income) of the same year and/or preceding tax year.

• A qualifying loss made in the first four tax years of letting may be carried back
  up to three years against general income.

• Income from this source can be used to calculate entitlement to tax relief
  on pension contributions.

• Capital allowances on qualifying plant and machinery (including furniture)
  for use in a FHL are available.

• Capital gains made on the sale of a FHL can be ‘rolled over’ against the cost
  of buying another similar property (or any other qualifying asset used in a
  trade) purchased up to a year before or three years after the date of sale.

• If a property is gifted, a claim can be made to ‘hold over’ the gain so that it
  does not become due until the recipient sells it.

• Capital gains arising on the disposal of FHL businesses are eligible for Entrepreneurs’ Relief. The effect of the relief is to reduce the gains qualifying
  for relief by an amount which results in an effective CGT rate of 10%. There
  is a lifetime limit of £2 million of gains that qualify.

• For inheritance tax purposes it may be possible to claim a reduction of up
  to 100% in the value of the property passing on death or on a chargeable
  transfer (this is subject to conditions which HMRC impose).

If you own FHL properties as well as other let properties you are required to keep
the activities separate for the purposes of calculating income and establishing
available reliefs.

In circumstances where a home owner lets part of their home to a lodger, rental
income is only chargeable to income tax where the income from the property as a
whole exceeds £4,250. In this situation no expenses are tax deductible. If more
beneficial, expenses can be deducted from income under the normal rules as
described above.

Obviously some reduction in liability can be created by having joint ownership with
individuals who are either not liable to tax or pay at a rate below 50%. Other routes
are available to hold property but there are issues which need to be carefully
considered.

Using a company
Rental income in a company will usually be taxed at the small companies rate
(currently 21%). This seems to be attractive when set against a potential 50% rate
for an individual. If rents are significant this may be an option to consider although
there are additional compliance problems to deal with, not least Companies Act
requirements.

From a tax viewpoint it must be remembered that income has to be extracted from
a company by an individual generally either as salary or dividend and that this
may trigger a tax liability. It is also important to remember that when a property is
sold by a company any gain is generally only reduced by an inflation allowance.
Other reliefs are generally not available. The gain (after CT) then has to be
extracted from the company at a further additional cost.

Using a trust
There may be estate planning opportunities to consider in using a trust to hold
rented property. The type of trust will determine the income tax rate but this coul
be 50% and the CGT rate for all trusts is currently 18%. However, the assets in the
trust may be effectively placed outside any individual’s estate for IHT purposes,
which may give some significant tax savings over a long period.

There are many issues to consider here and this is an area where specialist
advice is needed. Please talk to us if you would like to discuss any of the matters
raised in this briefing.

Disclaimer - for information of users - This briefing is published for the information of clients.
It provides only an overview of the regulations in force at the date of publication, and no action
should be taken without consulting the detailed legislation or seeking professional advice.
Therefore no responsibility for loss occasioned by any person acting or refraining from action
as a result of the material contained in this briefing can be accepted by the authors or the firm.