Tax Return 2016-17:
With some costs it’s very easy to decide: a repair to a drain, downspout or roof tile are all allowable expenses, but what about replacing a broken single glazed window with a new plastic frame and double glazing, what about decorating and installing a new kitchen before the property is let?
Before you can decide on these matters in accord with the HMRC rules, the actual situation needs to be defined. For example, the rules differ if the landlord is not resident in the UK, if the property business is run as a company, or if the properties are let as holiday homes, as opposed to conventional residential lettings.
Where the property is owned jointly between a married couple or civil partners, then income and expenses must be split on a 50:50 basis, but if the property is owned unequally then HMRC form 17 “declaration of beneficial interests in joint property and income” must be completed. On the other hand, where joint owners are not married or civil partners, the income can be split any way they choose.
When the letting business consists of more than one rental property, all income and expense are pooled as one business operation, and any losses incurred in the early years can be carried forward and set off against future profits.
The “Wholly and Exclusively” test
You cannot claim expenses for items which are not used “wholly and exclusively” for the letting business. For example, the landlord’s insurance policy, the letting agent’s fees, or service charges on a leasehold are all obviously only for the business. However, purchasing a computer, or tools and equipment, such as an electric drill, will not pass the test as these will also be available for personal use.
The capital expenditure test
Capital expenditure is generally defined as spending on a fixed item in or of the property. An asset or improvement of “enduring benefit”, which increases the value of a property, one which lasts for more than one accounting period. This would usually be more than one fiscal year or 6th April to 5th April. Capital expenditure therefore is not allowed as an expense (revenue) item to be claimed against annual income, but rather something to be set-off against capital gains when the property is eventually sold.
So, whereas repairs to existing items would usually pass the capital expenditure test, improvements generally will not. We say generally will not, as there are some instances where a technical improvement could be allowed. The example used above for replacing a single glazed window with a modern double glazed one may be a case in point. A rotted window frame gives the landlord no choice but to replace, but if the only option is a new modern double glazed window, and these are now a minimum legal requirement, then this would usually be allowed. But, in the eyes of HMRC, every case is judged on its merits and there are many “grey” areas between repairs and replacements / improvements.
Generally, any fitted item added which was not there before, for example, a conservatory, is capital expenditure. Any like for like replacement is allowed, but where it constitutes an improvement the expense may have to be apportioned. For example, replacing a wooden worktop with a marble one would be an improvement on the old ones, so only a portion of the cost can be claimed, unless it can be shown beyond doubt that it is impossible to replace like for like.
It is very important to keep long-term records and documentation for capital expenditure as these items can be claimed against capital gains when the property is eventually sold, to reduce Capital Gains Tax ((CGT) liabilities.
Repairs and Maintenance or Replacement test
The HMRC definition of maintenance and repair is “work that restores an asset to its original condition”. This may sometimes means replacing part of the item within the property or as part of the structure, for example, kitchen units or the guttering respectively. However, this is on a like-for-like basis as explained above.
Any work the landlord does personally, or is the subject of an insurance claim, unless there has been a contribution, cannot be claimed against income. Typical maintenance and repair items would include:
- Broken fixture items such as toilets, sinks, baths, showers, so long as they are like for like replacements.
- Plumbing leaks and any water damage done, such as re-decorating.
- Replacing a broken boiler, radiators and heating system repairs.
- Outside work including ridges, flashing, gutters, chimneys and roof tile repairs. Treating for wet and dry rot and dampness.
- Regular maintenance items such as carpet cleaning, decorating and outside items such as painting, and broken windows and doors are all allowable expenses.
- A worn-out kitchen replacement can be classed as a repair providing the replacement is like-for-like.
An important principle is that the initial purchase of non-fitted domestic items such as furniture and appliances is not allowed as an expense item, but their like-for-like replacement is.
Now the 10% wear and tear allowance has gone items must be claimed for on a one-off basis, but whereas before the house had to be fully furnished, this is no longer a requirement. Domestic items that replacements can be claimed for include:
- Any movable furniture, including chairs, settees, beds, freestanding wardrobes etc,
- Soft furnishings such as carpets, curtains, cushions, linen, other floor coverings,
- Household appliances, including washing machines, fridges and freezers, TVs.
- Kitchenware such as Sause pans, crockery and cutlery.
All replacements items must be of a similar value, supported by a purchase invoice of the actual cost to the landlord, and the item must be available for use in the property permanently. Any improvement or “betterment” involved will not be claimable.
The “Grey” areas between Capital and Expenses
Items replaced with better (more expensive) replacements have an element of capital and revenue expense in them, therefore betterment will be involved.
With a long-leasehold property, a lease extension puts value on the property so is classed as capital expenditure, but if the extension is for 50 years or less, this can be claimed as an expense item.
With most of the items mentioned above it is routine to claim against rental income for these, but it’s a different matter when setting-up a new rental house, when then all items of initial expenditure are added to the asset itself as an initial purchase – a capital item – and therefore not allowable as an expense. This will be covered in the next (No 3) article.
This is the 2nd in a series of articles designed to help landlords with their book keeping and self-assessment tax return for the tax year April 6th 2016 to April 5th 2017.
The Self-Assessment Tax Return, HMRC Form SA100, and Property income supplementary – HMRC Form SA105 – available here
Declaration of beneficial interests in joint property and income – HMRC Form 17
Filing your tax return online here
Free LandlordZONE Excel Tax workbook tool – download it here – https://www.landlordzone.co.uk/documents – go to Tax Tools & Documents
Next Article in the series – What is an Allowable Expense?
HMRC is increasing its targeted compliance activity across the private rented sector through taskforce activity – see HMRC – Tackling the Hidden Economy
HMRC says it is encouraging those who have been non-compliant to come forward through activities such as the Let Property Campaign©LandlordZONE® – legal content applies primarily to England and is not a definitive statement of the law, always seek professional advice.