Your company recently purchased and refurbished a couple of residential properties which are now let. Which costs can reduce your company’s rental income and which ones should be capitalised?
Rental business
The costs of starting and running a residential property rental business fall into three broad categories: (1) acquiring and improving a property, which is capital and tax deductible when calculating the gain or loss made when you sell or transfer the property; (2) day-to-day costs including repairs and maintenance, usually deductible from rental income; and (3) expenditure on furnishings and equipment which usually counts as capital and might not tax deductible at all.
Tip. Detailed analysis of expenditure, especially for new rental businesses, is vital to ensure expenditure is allocated to the right category. This can save you tax and prevent trouble with HMRC. Make sure you keep a record of your analysis.
Trap. HMRC insists that for new property rental businesses some start-up costs categorised as repairs normally deductible from income should be treated as capital. Consequently, this can mean it’s delayed until the sale or transfer of the property.
Pre-rental expenses
The Trap is only an issue if you spend money refurbishing a property before letting. The general rule for pre-letting expenditure is that you’re entitled to a tax deduction for it against income when your letting begins. The trouble is HMRC argues that the general rule doesn’t apply to pre-letting expenses on repairs and maintenance. Instead it suggests you must treat it as part of the cost of acquiring the property, i.e. capital expenditure, which can mean you receive no tax relief at all or at best it’s delayed as per the Trap.
Capital expense in disguise
HMRC’s view seems unfair but there is there is a logic as the following example shows. Acom Ltd buys a property with a view to letting it. The property is in poor condition and Acom spends money repairing the roof, walls, windows and installing new wiring at a cost of £30,000. Had this been spent after the property had first been let HMRC would accept it as deductible from Acom’s rental income. However, it argues that the condition at the time of purchase meant that Acom was able to buy the property at a lower price than had it been in good condition. In other words, by refurbishing the property after purchase it substituted capital expenditure for repair and maintenance costs.
How much?
In our example, the amount of refurbishment costs that should categorised as capital is a grey area and HMRC’s guidance isn’t helpful. It seems to imply that all such expenditure is capital. However, the courts have taken a different view on several occasions. Case law says that if a property was fit for purpose when bought, that’s to say it could be let, then all refurbishment expenditure is deductible from letting as income.
Tip. Where only some of the refurbishment costs are needed to bring your property to letting standard, only that part need be treated as capital (and not deductible from rental income). The balance is deductible from letting income under the pre-trading expenses rule.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.