Sarah Bradford explains how landlords can secure tax relief for capital expenditure when they prepare their accounts using the cash basis.
The cash basis is the default basis of accounts preparation for landlords with rental receipts (calculated on the cash basis) of £150,000 a year or less.
Where a landlord is eligible for the cash basis, this is generally preferred as it is simpler to apply than the traditional accruals basis. Landlords who are eligible for the cash basis but who prefer to use the accruals basis must elect to do so.
The cash basis works on a ‘cash in, cash out’ basis; receipts are recognised when the income is received, and expenses are recognised when paid. There is no need to match income and expenditure to the period in which it is incurred; nor is there any need to take account of debtors and prepayments or of creditors and accruals.
In addition, the rules for securing relief for capital expenditure are different under the cash basis.
Normal rules: No deduction for capital expenditure
Under traditional accounting under the accruals basis, revenue expenditure is deducted in working out the taxable profits for the property rental business.
However, capital expenditure cannot be deducted in working out the profits. Where relief is available, it is either given through the capital allowances system or when working out any chargeable gain on the eventual disposal of the property. For residential landlords, the availability of capital allowances is limited.
Cash basis rules
Special capital expenditure rules apply under the cash basis, which allow the landlord to simply deduct the capital expenditure when computing the profits for the property rental business. The deduction is made in the period in which the expenses are paid, unless the expenditure is of a type for which such a deduction is expressly prohibited.
A deduction is not allowed for capital expenditure that is incurred in, or in connection with, the provision, alteration or disposal of land. Relief for these costs will be given under the capital gains tax rules on the eventual disposal of the land.
However, this restriction does not prohibit a deduction from being made in respect of expenditure on an asset which is installed or otherwise fixed to qualifying land so as to become part of the land unless the asset is one of the following (in which case the expenditure is not deductible):
- a building;
- a wall, floor, ceiling, door, gate, shutter or window or stairs;
- a waste disposal system;
- a sewerage or drainage system; or
-
a shaft or other structure in which a lift, hoist, escalator or moving walkway may be installed.
Under the cash basis rules, a deduction is also specifically disallowed for expenditure on an item of a capital nature which is incurred on or in connection with the provision, alteration or disposal of an asset for use in an ordinary rental property. This is subject to the relief for replacement domestic items (which applies under the cash basis as under the accruals basis) and provides for a deduction of domestic items where the replacement is on a like-for-like basis. An ordinary rental property is a residential property in relation to which an ordinary property business is carried on (but which excludes furnished holiday lettings).
No deduction available
The cash basis rules also prohibit a deduction for expenditure on an item of a capital nature incurred on or in connection with the provision, alteration or disposal of:
- any asset that is not a depreciating asset;
- any asset that is not acquired or created for use on a continuing basis in the property business;
- a car;
- a non-qualifying intangible asset; or
-
a financial asset.
Depreciating assets are those where on the date on which the expenditure is incurred, it is reasonable to expect that within 20 years of that date, the useful life of the asset will end, or its value will decline by 90% or more. The useful life ends when the asset can no longer be of use to any person as an asset of a business.
Intangible assets include internally generated intangible assets and intellectual property. A non-qualifying intangible asset is, broadly, one that will cease to exist in 20 years.
A financial asset is any right under or in connection with a financial instrument or an arrangement that is capable of producing a return that is economically equivalent to a return produced under any financial instrument.
Capital allowances
As the cash basis capital expenditure rules allow a deduction for capital expenditure (unless such a deduction is prohibited), capital expenditure is relieved in full in the period in which the expenditure is incurred. Consequently, capital allowances are not available (as this would duplicate the relief).
The unavailability of capital allowances extends to the annual investment allowance and first-year allowances, as well as to writing-down allowances. However, relief by deduction under the cash basis rules achieves the same end result as the annual investment allowance and the 100% first-year allowances in securing relief in calculating taxable profits in the period in which the expenditure is incurred.
Cars are the exception to this rule; a landlord using the cash basis is not allowed to deduct the cost of the car in computing profits as a deduction for the cost of a car is specifically prohibited. Consequently, a landlord may be able to claim capital allowances in respect of a car. However, if the landlord uses mileage allowances to claim a deduction for business travel, capital allowances cannot be claimed.
Capital gains tax
Where relief is not obtained under the cash basis capital expenditure rules by deduction because the expenditure is of a type for which such a deduction is prohibited and relief is not available via the capital allowance system, relief may be available for capital gains tax purposes in computing the gain or loss on disposal. Relief for the cost of the land and any improvement expenditure will be given in this way.
Capital receipts
As a deduction may be given for capital expenditure in computing profits under the cash basis, disposal proceeds from capital assets (such as vans) are treated as a capital receipt if the receipt is received in a year where the cash basis was used, and the associated expenditure was deductible (or would have been had the cash basis been used in the year in which the expenditure was incurred).
Example: New van, car and property
Malcolm is a landlord and he has a number of residential properties that he lets out. His rental receipts are £80,000 a year and he calculates his profits using the cash basis.
In 2021/22, he purchased a new van for £15,000, selling his old van for £3,000. He also purchased an electric car, costing him £25,000. He does not claim mileage allowances.
He acquired a new property to add to his rental portfolio for £120,000 and spent £50,000 on an extension.
When preparing his accounts under the cash basis, Malcolm can deduct the cost of the van in calculating his profits. However, he must also bring the disposal proceeds of the old van into account, which are treated as a capital receipt. Although Malcolm is not able to deduct the cost of the car because he is not claiming mileage allowances, he can claim capital allowances. As the car is an electric car, he can claim a 100% first-year allowance, giving immediate relief for the expenditure.
Deductions for land and extensions are not permitted under the cash basis capital expenditure rules. However, when the new property is sold, the initial cost plus the cost of the extension can be deducted in computing any gain or loss on the sale.
Practical tip
Landlords using the cash basis to prepare their accounts should ensure that they are familiar with the cash basis expenditure rules so that permitted deductions for capital expenditure, which will reduce their taxable profits and thus the tax that they have to pay, are not overlooked.
