Tax on income from lodgers and short stay tenants

Landlords’ Tax:

Internet sites, such as AirBnB, have increased the number of landlords letting to lodgers and to guests on short stays.  There are specific tax benefits to this type of letting business which are expanded upon below.

Furnished holiday letting

Letting a property to a succession of tenants on short stays could qualify a property for preferential tax treatment.  A property may be regarded as a “Furnished holiday letting� (FHL) if it is furnished and situated within UK or European Economic Area.  For each tax year, it is a requirement that the property is:

• Not let out to the same person for more than 31 days. This is unless the 31-day periods are less than 155 days a year;
• Available for letting at least 210 number of days each tax year; and
• Actually let for 140.

It can be a matter of interpretation as to whether a property is available for letting.  However, it is self-evidently not available while undergoing extensive works or while the owner is living in the property, as the sole occupier.

When it is first let, the initial twelve months can be used (rather than tax year) as a reference period.

FHL benefit from a number of tax reliefs:

An amount borrowed to fund the letting business will be treated as a loan to a trader.  Loans in this sense include a mortgage secured on the rental property.  As such, the full amount of interest is tax deductible.

This contrasts with other types of residential rental income, where interest can only be a tax reducer.  When fully phased in on 6 April 2020, tax liability will be reduced by an amount equal to 20% of interest payable on business loans and mortgages.  The restriction on deduction of interest is a particular tax drawback to landlords who are higher rate taxpayers.

On disposal of the property, either by sale or as a gift, the landlord can enjoy certain capital gains tax reliefs.

The tax reduction which is most commonly enjoyed derives from Entrepreneur’s Relief.  This will allow gains to be taxed at an effective rate of 10%.

By way of comparison, a higher rate applies to residential rental property which is not FHL.  The capital gains tax rate is 18% to the extent the vendor is a basic rate taxpayer and 28% thereafter.

To the extent that the proceeds from disposal of the FHL are reinvested in another business assets, the capital gains tax can also be deferred.  This would provide a cash flow advantage to a landlord seeking to reinvest the proceeds from one FHL to another.  It is also possible to dispose of the property as a gift and make the beneficiary liable for any capital gains tax.

Rent-a-room-relief

AirBnB and similar websites have facilitated an increase in short stay lodgers.  However, regardless of the length of tenancy, special tax relief is available to a live-in-landlord.  Expenses for lodger income can be calculated by two methods:

The actual method takes a proportion of total household costs which are attributable to the space being let.  This proportion is typically calculated by reference to floor area.

The rent-a-room relief allows a fixed amount (of £7,500 for 2018-19) to be deducted from profits.

If income from a lodger is less than £7,500, there are no taxable profits.

Claiming rent-a-room relief for a tax year does not oblige the landlord to claim the relief for every tax year thereafter.  The actual basis is preferable to rent-a room basis where it produces lower taxable profits.  Since the £7,500 allowance cannot create a loss, the actual basis can the favoured option in a loss-making year.  This is because if the expenses exceed income, the surplus costs can be treated as expenses of a future year.  In technical terms, the loss is carried forward to a future year.  An exceptional loss-making year could occur, for instance, due to a vacant period or higher than usual repair costs.

Typical costs which can be deducted from taxable rental profits include letting agent fees, building insurance, repair costs and accountancy fees.  From 2017-18, there have been special rules on the deduction of mortgage interest from rental profits.

The £7,500 applies regardless of the number of lodgers.  The threshold is more likely to be exceeded as the number of lodgers increases.

Capital gains tax for live-in landlords

Capital gains tax applies to a property that a person does not live in, even if it is the only place that they own.  By contrast, a person’s home is not liable to capital gains tax.  However, that part of the home which is used for letting is liable to tax, except if it let to no more than one lodger.  There is no need to report any capital gains tax on disposal of a home if let to only one lodger.  The interpretation of a letting business as being comprised of more than one lodger is explained in the HMRC Statement of Practice SP14/80.

It would be necessary to apportion business use where the property has been partly let and partly lived in by the owner.  The apportionment would be based on:

• The percentage floor area let; and
• The amount of time the property was let as a proportion of the total amount of time the property was owned.

Even where the property is let to more than one person, lettings relief and principal private residence apply.  Letting relief will usually exempt the gain attributable the period in which the property was let.  The tax relief covers the first £40,000 of gain made by each owner.  Principal private residence relief exempts the last 18 months of ownership even if the property was not being lived in during that period.

Altering a home into two separate dwellings to facilitate a tenant will cause loss of principal private residence relief and lettings relief.  An obvious distinction of a separate dwelling for these purposes is usually an outside entrance.

Provided the lodger income does not give rise to a tax liability, there is no need to apply to HMRC for the relief.  The tax exemption applies automatically.  It is not a requirement to file a Tax Return if lodger earnings are less than the £7,500 threshold explained above.

Where there is taxable rental income, or where the taxpayer wishes to report a loss, a Tax Return requirement arises.

Where more than one landlord is entitled to the lodger’s rent, rent-a-room relief is divided by two, into £3,750 per person.  This is often the case where the home is jointly owned by a married couple.  The whole allowance is still available where the property is only let for part of the tax year.

Rent-a-room-relief will not apply where:

• The property is not furnished, or it is business accommodation; or
• The landlord is not living in the property when it is let.

The rise in popularity of internet search portals, such as AirBnB, has facilitated the letting of a person’s home for short periods, such as when the owner is away on a short holiday.  The owner is not a live-in-landlord while away for this period.  Consequently, HMRC have stated that with effect from April 2019, a person must stay in the property for at least part of the period in which it is let for that lodging income to be eligible for rent-a-room-relief.

On the other hand, there is no stipulation regarding the lodger’s length of stay.  Therefore, a bed and breakfast provider can make use of the allowance, provided they reside in the same property as the guest.

Relief of £1,000 for micro-entrepreneurs

If the relief is not available, actual expenses can still be deducted in calculating taxable profits.  If total expenses are less than £1,000, an amount of £1,000 can be deducted from taxable profits instead.  The relief for so called microentrepreneurs has been available since April 2017.  Income which is below £1,000 is exempt from tax.  There is no need to file a Tax Return to report income of less than £1,000.

The rise of internet use has changed the dynamics of the letting market.

AirbnB and similar portal websites help an increase in people;

• Letting a spare room in their home;
• Letting their home while away, for instance on holiday
• Letting their second home, or rental property to a succession of short stayers, rather than on a agreements for six months or longer.

The table below summarises the tax rules which apply to this type of income:

	Let long term	Let short term
Home	Rent-a-room relief applies	Rent a room and furnished holiday letting relief could apply.
Secondary residence	Neither rent-a-room, nor furnished holiday letting relief available.	Furnished holiday letting may apply

 

The guidance provided above is broad in nature and correct at the time of writing.  It is not a complete summary of the rules.  In many cases the tax benefits explained above would not be applicable.

Ray Coman, FCCA, CTA is a Chartered Accountant and a Director of Coman & Co Ltd, specialising in tax accounting for landlords.

https://comanandco.co.uk/

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