Sarah Bradford explains how tax relief may be given for capital expenditure.
The tax system distinguishes between capital and revenue expenditure, and different mechanisms exist to confer relief for that expenditure.
Capital expenditure is incurred on items that are retained within the property business and which either form part of the land or structure or are used to generate revenue. In the context of a property business, items of capital expenditure will include the land and property itself, and fixtures and fittings, furnishings and domestic appliances.
Different ways of securing relief
Not all capital expenditure is equal. In some cases, relief is available when computing the profits of the business, whereas for other items of expenditure, relief is only given when computing the eventual gain or loss on the sale of the property.
The extent to which relief is given, and the way in which relief is given, does not only depend on the type of expenditure; it also depends on the nature of the property business, as different rules apply to different types of property business, and on the way in which the accounts are prepared.
Consequently, navigating relief for capital expenditure can be something of a minefield.
Accounts preparation
The way in which the accounts are prepared will determine, in part, the way in which the relief is given.
Unincorporated property businesses with rental income of £150,000 per annum or less, which meet a number of other conditions, must use the cash basis to work out their taxable profit or loss, unless they elect not to use the cash basis. The cash basis is more straightforward as it takes account only of money in and money out – there is no need to calculate debtors and creditors or accruals and prepayments. Also, as income is only taxed once payment has been received, relief is given for bad debts automatically.
The option of using the cash basis is not available to property companies, or to unincorporated property businesses that have rental income (calculated under the cash basis rules) of more than £150,000 a year. These businesses must use the traditional accruals basis to work out their taxable profit or loss. Under the accruals basis, income and expenditure is taken into account in the accounting period to which it relates, rather than the period in which it is received or paid. This necessitates the calculation of debtors and creditors, and of prepayments and accruals.
Treatment of capital expenditure under the cash basis
There are dedicated rules that govern the way in which relief for capital expenditure is given where accounts are prepared using the cash basis. Relief for capital expenditure is given as a deduction in computing the profits of the period in which the expenditure is incurred, unless the expenditure is of a type for which deduction is excluded. It should be noted that the list of exclusions is extensive.
Under the cash basis rules, a deduction is permitted for items of capital expenditure except for those incurred in connection with:
- the provision, alteration or disposal of land;
- the provision of buildings, walls, floors, ceiling, doors, gates, shutters, windows or stairs;
- the provision of waste disposal systems or sewerage or drainage systems;
- the provision of shafts for hoists, escalators or moving walkways;
- lease premiums;
- the acquisition or disposal of a business, or part of a business;
- the provision, alteration or disposal of an asset for use in an ordinary residential property not used as a furnished holiday let;
- non-depreciating assets;
- cars;
- intellectual property and other non-qualifying intangible assets; and
-
financial assets.
It should be noted that special rules apply to provide relief for domestic items used in a normal residential let.
The availability of the special cash basis rules means that capital allowances (including the annual investment allowance) are not generally available. The exception to this rule is in relation to expenditure on cars for which a deduction is unavailable under the cash basis rules, and in respect of which capital allowances can be claimed instead.
Relief for the cost of the land and property itself, and for any enhancement or improvement expenditure, is taken into account when computing any gain or loss on the sale of the property. No relief is available when computing profits.
Treatment of capital expenditure under the accruals basis
Where accounts are prepared under the accruals basis, no deduction is given for capital expenditure. Instead, to the extent that the expenditure counts as qualifying expenditure, relief is available in the form of capital allowances, including writing down allowances and the annual investment allowance.
Where the property business is operated through a company, the 130% super-deduction or the 50% first-year allowance may be available if the expenditure is incurred in the period from 1 April 2021 to 31 March 2023 on new (rather than second hand) items.
The capital allowances legislation treats UK property businesses, overseas property businesses and furnished holiday lettings (in the UK or the EEA) as a qualifying activity, meaning that plant and machinery capital allowances may be available for certain expenditure on plant and machinery. However, other than furnished holiday lettings, capital allowances cannot be claimed on furniture and furnishings.
As under the cash basis, relief for the cost of the land and property itself, and for any enhancement or improvement expenditure, is taken into account when computing any gain or loss on the sale of the property.
Domestic items
Special rules apply which govern the extent to which relief is available for expenditure on domestic items provided in a residential let. The rules do not apply to furnished holiday lettings. The rules deny relief for the original cost of the item but allow relief as a deduction when computing the profits when the item is replaced.
The relief is available where a property business includes the letting of a dwelling-house and applies where an old domestic item which has been provided for use in a dwelling house is replaced with a new domestic item. The new items must be available for the exclusive use of the lessee and the old item must no longer be available for use by the lessee. The available relief is capped at the cost of a like-for-like replacement, plus any costs associated with the acquisition or disposal (such as delivery). To prevent double relief, the relief is not available where it has already been given under the cash basis rules, or where capital allowances have been claimed.
This relief is not available if the property is a holiday letting, or if rent-a-room relief has been claimed.
Furnished holiday lettings: furniture and furnishing
Furnished holiday lettings benefit from a number of advantageous tax rules. One of these is the ability to claim capital allowances in respect of expenditure on furniture and furnishings, including the annual investment allowance. This is beneficial as, where the annual investment allowance is claimed, relief can be received in full in the period in which the expenditure is incurred, and significantly, on the initial purchase of the items and when they are replaced.
This is a considerable advantage over the rules applying to standard residential lets in respect of which the landlord receives no relief for the initial cost of domestic items and furniture provided for use in the property.
Capital gains tax relief
Where relief for capital expenditure is not available by deduction or under the capital allowances rules, relief may be available against capital gains tax in computing any gain or loss on the sale of the property.
Tax relief is given in this way for the purchase cost of the property itself, as well as for any subsequent improvement or enhancement work.
It is important that records are kept of both the initial cost and any work undertaken as significant time may elapse between the date of acquisition and the date of sale, and it is easy for capital improvement expenditure to get overlooked.
Practical tip
Make sure that you understand how the rules work and when relief is available in different circumstances, depending on the nature of the capital expenditure, the type of property business and the way in which the accounts are prepared. Keep records and receipts to ensure available relief is not overlooked.
