Lodger and guest house income
Written by Ray Coman
Internet search engines such as AirBnB have facilitated the short stay and lodger lettings market. There are a number of tax benefits to these arrangements which are explored below.
Letting a property to a succession of tenants throughout the year is encouraged through the tax system. In order to qualify as a furnished holiday letting (FHL), the property:
- Must not be let to the same person for more than 31 days in succession. If let to the same person for more than 31 days, the total of these periods should not total more than 155 days;
- The property must be available for letting at least 210 days in the tax year;
- The property must be actually let for at least 140 days in the tax year; and
- The property should be situated in the UK or in the EEA.
The first twelve months is used as a basis period in the initial year, and the tax year thereafter.
A FHL confers various tax benefits:
Any borrowing which is used for the furniture holiday letting, which includes a mortgage secured on that property, would be treated as a loan to a trader. Consequently, the interest can be deducted from taxable profits in full. The property is not subject to the restriction that applies to other types of property income.
The property is treated as a business asset for capital gains tax. This means that Entrepreneur’s Relief applies when the property is either sold or transferred as a gift. Most residential property is subject to the usual rates of capital gains tax. For 2018-19, an individual is liable to capital gains tax at a rate of 18% to the extent that taxable gains and income are less than the higher rate tax threshold. A rate of 28% applies to gains thereafter. In many cases, the rate of capital gains tax on disposal of an investment property is roughly 28%. The rate applicable to FHL property is 10%.
Business asset roll-over relief can also be applied to FHL. Provided sale proceeds are reinvested in a replacement business asset, which would include a FHL, the capital gains tax on the FHL is deferred until sale of the replacement assets. Roll over relief provides a cash flow benefit to a landlord wishing to reinvest proceeds from one FHL into another.
In some cases a FHL can be transferred as a gift and the capital gains tax liability effectively transferred to the recipient. This is known as hold over relief.
A landlord can deduct certain expenses from rents received in calculating taxable rental profit. Instead of deducting actual expenses, an amount of up to the rent-a-room relief threshold can be deducted from taxable rental profits.
The relief is available to a landlord who lives in the property being let. Where a property is a separate dwelling, as evidence by a distinct door entrance, the rent-a-room relief would be lost.
A threshold of £7,500, per landlord, applies for 2018-19. This allowance is divided in half where there is more than one landlord, for instance where a property is jointly owned by a married couple. The full relief applies even if the property was only let for part of the year.
As an alternative to rent-a-room relief, a landlord could deduct a proportion of actual letting costs. The percentage floor area used by the lodger is a typical method of apportioning costs. Costs which can be deducted from rental profits include letting agent fees, repairs, and building insurance. Elsewhere on the website provides a more comprehensive list of property expenses.
A landlord can choose each tax year which method is more tax-beneficial. The actual basis would be more favourable if it creates more profit, or if it leads to a loss. This is because the excess of rent-a-room allowance over profits is not an allowable loss for tax purposes.
Capital gains tax implications
A person’s home is exempt from capital gains tax. The exemption still applies where the home is only let to one lodger. In Statement of Practice SP14/80, HMRC state that the letting of a property to only one lodger is not regarded as business use. If there is more than one lodger, however, the taxable part of the gains is calculated by applying both:
• The percentage floor area used by the lodger;
• The time that the property was let for as a percentage of the time that the property was owned.
The business proportion of the property is further reduced by lettings relief which is capped at £40,000 per owner. The final 18 months of ownership is a deemed period of occupation. Gain apportioned to the last year and a half is therefore not taxable, even if the property was let during this period.
Tax Return requirement
If a lodger’s income is less than the rent-a-room relief, there is no tax liability, and no need to complete a Tax Return for this reason alone. The rent-a-room-relief allowance applies automatically. It is not a requirement for a landlord to notify HMRC about rental income from a lodger if the income is below the rent-a-room-relief threshold.
Letting while away
Rent-a-room relief will not apply:
- Where the landlord lets their property while not living in it.
- If the property being let is business premises.
AirBnB and similar internet portals, have given rise to landlords letting homes while away for a short spell, such as on holiday. As a point of clarification HMRC has stated that even for lettings of a short duration, rent-a-room relief will not apply unless there is at least some overlap between the period that the landlord and tenant live in the property. The new rules take effect from April 2019.
Where the above rules apply, actual expenses can be deducted from rental income in calculating profits. Since April 2017, a flat rate of £1,000 can be deducted from income as opposed to actual expenses. Therefore, there would not be a tax liability where rental profit is less than £1,000. A Tax Return requirement has not arisen.
The relief is useful to live-in-landlords, including those providing bed and breakfast service.