Property Income (Rental Income) – What expenses can Landlords claim when declaring their rental property income to HMRC? Revenue or Capital expenditure? Can I claim new kitchen replacement on my Self-assessment tax return? Is renovation costs for the entire whole property an allowable expense? Landlords in the UK consistently try to improve their rental properties as properties that are generally well maintained would generate higher rental income than non well maintained or damaged properties (well that’s obvious).
As rental income is taxable income, many landlords try to reduce their tax burden by claiming as much tax relief as possible. However, HMRC has strict guidelines on what are allowable expenses and what expenses can not be used to offset against the rental income. Many landlords and properties owner struggle to distinguish between revenue and capital expenditure. When the time of the year comes to submit a self-assessment tax return, many landlords make the mistake of claiming capital expenditure against the rental income which is against the HMRC rules and guidelines and may result in fines and penalties for inaccurate submission if HMRC decides to investigate. In this blog, we will try to explain the differences between these accounting terms and which rental expenses are “allowable expenses”.
Allowable vs Disallowable expenses
Allowable expenditures are expenses which HMRC allows and accepts as deductible expenses which a landlord can use to offset against the rental income. Although from an accounting point of view all expenditures can be considered as fair and proper, for the purpose of taxation only specific expenses are allowed. These are, for example, depreciation on a non-current asset such as washing machine or any other non-current asset is not allowable expenses for the purpose of taxation. It does not mean the rental accounts prepared from an accounting point of view are necessarily wrong, adjustments need to be made to only reflect allowable expenses for the purpose of taxation.
What are allowable expenses?
The general rule for an expenditure to be allowable, it must be revenue in nature, except for some replacement items. In addition, these expenses should be “wholly and exclusively” for the purpose of lettings. If the expenses do not meet these criteria, it should not be taken into account for the purpose of calculating the net rental income. Examples of allowable expenses include:
- Utility bills, water rates, business rates
- Finance charges i.e mortgage interests (25% mortgage tax relief for 2019/20)
- Management fees, estate agent fees, services charges
- Insurance, e.g business insurance, landlord insurance
- Advertisement and Marketing costs, e.g advertising for tenants
- Ongoing repairs, maintenance and redecoration costs (revenue in nature)
- Irrecoverable rent (accrual basis)
- Travel and fuel costs to inspect the property
- Replacement of domestic items
As long as these expenses meet the above criteria, HMRC allows these to be used and set against the rental income. Does the timing have an effect? Short answer, no. If you have incurred these expenses before the property was rented out to tenants or in periods between rental periods (“void” periods) this is also acceptable. However, these expenses are not allowed during periods when the property is used privately e.g when you or your family members are living there without paying rent.
Scenario 1 – Expenses incurred before the tax period: Mr A. has a property in Kingston Upon Thames which required some repairs and maintenance work after his previous tenants left the property. On 01 July 2019 Mr A. incurred repairs and maintenance costs of £2,500 before it was rented out to the new tenants. The tenants moved into the property on 1 August 019 on £1,750 p/m to a total of £14,000 for the whole tax year – in this case, Mr A. can offset the expense against the rental income for this 2019/20 tax year even though he incurred the expense before the tenants moved into the property.
What are disallowable expenses?
So, allowable expenses generally speaking are revenue in nature, but what about capital expenses? In essence, any expense that would improve the “value of the property” is considered as capital expenses which are not allowable expenses for the purpose of income tax. The following list give examples of disallowable expenses and as you will notice consists of mainly capital expenses.
- Cost of the property and any other costs associated with the purchase such as legal and professional costs
- Stamp duty, land tax, solicitor fees
- Cost of improvements as these would increase the value of the property
- Cost of furniture and fittings before the property is rented out for the first time
- Renovation costs before the property is rented out for the first time
- Any other costs associated with the initial purchase of the property
- Depreciation of capital expenditure – never an allowable expense for the purpose of taxation
- Expenses not associated with the letting property, for example, a private part of the property
Cost of the property and costs of improvement are not allowable expenses, however, these costs are used for the purpose of Capital Gains Tax (CGT) if the landlord later in the future decides to sell the property. Costs of improvements are also disallowable expenses as these would increase the value of the property, for example, if the property has no central heating and later on is installed, it will be considered as a capital expense. Other examples include building a garage, loft conversion, building an extension, replacing an old kitchen with much higher value materials and expenses customised items will also be considered as capital expenditure. However, any repairs and maintenance costs which bring the property back to its previous conditions are allowable.
The importance of declaring it correctly
As per HMRC guidelines, only allowable (mainly revenue expenditures) expenses can be used to offset against the rental income. If you claim capital expenditure against the rental income, this will decrease the net rental income and therefore reduce your tax liability for the year. If HMRC realises you submitted a tax return by claiming disallowable expenses, in most circumstances, impose heavy penalties and interest charges on the tax that should have been paid based on the net profit which should have only taken into account allowable expenses.
The difference between revenue and capital expenditure in most cases is clear but very often it is difficult to distinguish whether an expense falls as revenue or capital expenditure. Great care needs to be taken to ensure the tax return is accurate and only reflects allowable expenses, so if HMRC, later on, does investigate, you have the peace of mind that you have only claimed genuine and allowable expenses.
|Revenue Expenditure and other allowable Expenses||Capital Expenditure and other disallowable expenses|
|Utility bills, water rates, business rates||Cost of the property|
|Mortgage Interest||Costs associated with the initial purchase of the property|
|Management fees, estate agent fees, services charges||Professional costs, solicitors fees, stamp duty|
|business insurance, landlord insurance||Improvement costs i.e increase the value of the property|
|Advertisement and marketing||Renovation costs before the property is rented out for the first time|
|Repairs and maintenance costs||Depreciation of any kind|
|Other revenue expenditures|
|Replacement of domestic items|
Summary list of Revenue and Capital Expenditure