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The seven FREE property tax busting strategies course reveals the secrets of how to legitimately beat the taxman and boost your property profits!

 

 


Title: Landlord Tax Secrets

Strategy: Claiming pre-letting expenses 

Author: Amer Siddiq (UK landlord and entrepreneur)

 

 

Welcome to the fifth tax module!


I really hope that you have already benefited from my previous tax modules and have already appreciated that you can pay less tax to the taxman by simply following them.

In this module we talk about a big misconception regarding the costs that are incurred before a property is first let.

There is a common misconception among buy to let landlords – and some of their accountants – that the cost of repairs to a newly-purchased property cannot be claimed before it is first let out. We set out to prove that this isn’t always the case...

As I said at the end of the last tax module, I have personally used this strategy to avoid paying £THOUSANDS in taxes.

Just like the previous property tax modules, I recommend that you print off and file this lesson away so that you have easy access to it whenever you are off-line!

 

Claiming pre-letting expenses

In this module we look at whether expenses incurred before letting can be claimed against profits of a rental business. 

In the setting up of a rental business, it is not unusual for expenses to be incurred before the first rental payment is received. Such expenses typically include travel, phone, council tax, advertising and most importantly, repairs. Whether these expenses are tax deductible depends on a number of special rules not least as to whether they were incurred 'wholly and exclusively’ for the rental business.

Special rules

Income tax relief for pre letting expenses is only allowable where the expenditure was:

  • not capital expenditure

  • incurred 'wholly and exclusively' for the rental business and

  • incurred within a seven years before the date the rental business started

  • not otherwise allowable as a deduction for tax purposes (i.e. against any other income or capital); and importantly -

  • would have been allowed as a deduction if incurred after the rental business started

Difference: Income v Capital Expenditure

For income tax purposes profits from lettings are computed using the same principles as for a trading business. Therefore the tax deductibility of any expenditure in the annual income and expenditure accounts depends upon whether the expense is revenue or capital in nature. Capital expenditure produces an ‘enduring asset’ for the property; revenue expenditure does not. For some expenditure it is clear whether it is a capital or an income expense e.g. the adding of an extension to the property is capital - other expenditure may not be so clear-cut. If the expense is capital then the claim may not be lost as it might be deductible against any future gain on the disposal of the property as enhancement expenditure (so long as the improvement is still part of the property being disposed). If a loss is made on disposal then the expense will decrease the loss. 


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Allowable deduction for income tax 

If the expense can be designated a revenue expense then to claim as pre-letting expenditure it needs to have been allowable as if the rental business is already being carried on. A claim can be made if that expense was incurred seven years before the rental business commenced. The cost is treated as having been incurred on the day on which the landlord started the rental business, being added to other allowable letting expenses.

When does a letting business start?

A letting business starts when the first rental payment is received (if the cash basis of calculation is used) or when the rent is first recognised as due (accrual basis). A property needs to be in a condition so that it can be let, subject to cleaning, furnishing and the drawing up of tenancy agreements and inventories as well as adhering to any legal regulations. 

Expenses before letting commences

If the property was purchased as a rental property (or is a second rental property such that there is already a letting business in place) then any revenue related expenses paid before the first rental receipt will be allowable. However, if the first property requires renovation or was a main residence and/or not previously let, then expenses incurred before that first rental receipt are deemed to have been incurred for a purpose other than that of the lettings business, which has not yet commenced. These expenses will not be allowable as either an income tax or capital tax deduction. A typical example of such a disallowable expense is council tax which would have been paid whether or not a lettings business had subsequently commenced. 

Once the property letting business has started, any later expenditure leading up to the letting of subsequent properties is part of the rental business and can be deducted, as long as it qualifies as tax deductible. Expenses incurred in preparation for the letting of second and/or subsequent properties after the first property has been let are not pre-letting expenses because the business is already in existence at this point; they can be deducted but in accordance with the normal accounting rules.

Problem with Repairs

HMRC's approach is that repairs which increase the value of the property are "effectively improvement expenditure, which is therefore ‘capital' and not claimable against rents". Here they are looking at expenses such as installing central heating where none previously existed. HMRC's Property Tax Manual gives examples of allowable expenses such as "Repainting, replacing a broken window, or having the carpets cleaned". This will be the case whether the expenditure was incurred pre or post-commencement of letting.

Practical point
Repairs to reinstate a worn asset usually qualify as revenue expenditure Where a property is purchased that is not in a fit state to be let out unless repairs are undertaken, then that expenditure is likely to be capital.

Capital and income expenditure together

In a development project (e.g. where a property is being converted into a House of Multiple Occupation (HMO)) it is usual for there to be both capital and revenue expenditure. Where costs can reasonably be split between disallowable capital improvements and allowable maintenance or repairs, then the improvement element does not mean that the whole expense is deemed to be capital.

Example:
Jane converts a four bedroomed house into seven separate rooms under an HMO. The original kitchen will be retained (although updated), shower rooms will be placed in all rooms and a lift will be installed for access to rooms on the second floor. Expenditure incurred is split and claimed as follows:

Work undertaken Total Cost Revenue cost Capital Cost

Structural alterations    £15,000  £5,000     £10,000 
e.g. removal of walls

Rewiring – separate meters          £8,000     £2,000           £10,000

Replacement of kitchen **              £8,000     £8,000               NIL

Additional kitchen units **              £1,000       NIL  £1,000

Heating in communal areas ***     £2,000       NIL  £2,000

Redecoration      £5,000     £3,000  £2,000

Install lift ***     £15,000        NIL  £15,000

TOTALS     £52,000     £18,000   £35,000

** replacement of kitchen units to a similar standard is a 'repair'; additional fixtures are a capital improvement.

*** costs may be claimable under the capital allowances rules as 'common' areas. Under the 'accrual' basis of accounting the purchase of any capital item is dealt with under the capital allowance rules.  

Practical points

  • Should there be a legal requirement to fit items to a higher standard than is already in place specifically for letting (usually with reference to HMOs), then the expense is usually deemed to be an improvement and therefore a capital expense.
  • A surveyor's report often includes an estimate of the rental income that could be derived from the property, and this can be useful evidence that the property was fit for use before money is spent on repairs. Alternatively, photographs would be helpful in any future HMRC enquiries.
  • The landlord should keep records for any capital expenses alongside the property purchase, so that they are not overlooked when the property is eventually sold.

The Next Tax Module in Three Days' Time! 

Are you concerned about making mistakes where property tax is concerned, paying too much or not enough?

If 'YES' then in the next module I'll be looking at some of the more common mistakes that a landlord might make in relation to property tax.

Please do keep in touch and let me know how you find this property tax course.

See you in three days.

All the best,

Amer Siddiq
amer@property-tax-portal.co.uk

 

P.S. Please feel free to distribute this document and send it to anyone who you feel will benefit from this tax saving module.

 

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