Sarah Bradford explains when and how landlords can secure tax relief for expenses incurred prior to the start of the first let.
Landlords often expend significant time and money in getting properties ready to rent. As long as certain conditions are met, tax relief is available for pre-letting expenses. These are expenses which are incurred before the commencement of the property rental business.
Start of the rental business
To ascertain whether an expense was incurred before or after the start of the property rental business, it is necessary to establish the start date of that business. Where the business is the letting of property, the business starts with the letting of the first property. The business begins when the landlord receives income from the property for the first time.
Under the rules for taxing income from property letting, all income and expenses from the letting of property in the UK (subject to special rules for furnished holiday lettings) by the same person or group of persons are grouped together to work out the profit or loss for that property rental business. Consequently, the business comes into existence with the first letting. The letting of any subsequent properties forms part of an existing business. This is important for determining whether expenses are incurred before or after the rental business commenced and when any relief is given.
Pre-letting expenses
Expenditure is only pre-letting expenditure if it is incurred prior to the letting of the first property. It does not have to be incurred in relation to that property but must be incurred before the property rental business begins.
Expenses incurred in preparation for the second and subsequent let properties which are incurred after the first property has been let are not pre-letting expenses. The business is in existence at this point and the expenses are expenses of the property rental business and can be deducted in accordance with the normal rules for the deductibility of expenses.
Example 1: Acquisition of second rental property
James purchases an investment property in March 2022, which he plans to let out as a rental property. This is his first rental property. He spends some time and money getting the property ready to let and finding tenants. The property is let for the first time on 1 May 2022.
James completes on a second investment property on 15 May 2022. He decorates the property and prepares it for letting, and advertises for tenants. The property is let for the first time on 1 July 2022.
The property letting business commences on 1 May 2022 when the first property is let. Any expenses incurred prior to that date are pre-letting expenses. However, the property business is already in existence when the second property is acquired, and expenses incurred in relation to that property prior to its first letting on 1 July 2022 are expenses of an existing property rental business rather than pre-letting expenses.
Relief for pre-letting expenses
Relief for pre-letting expenses is given by reference to the rules that apply generally to pre-trading expenses incurred by businesses. For relief to be available, certain conditions must be met:
- the expenses must have been incurred not more than seven years before the start date of the business;
- no deduction is otherwise available for expenses; but
-
a deduction would have been given had the expenses been incurred once the business had started.
Consequently, in determining whether relief is available, initially it is necessary to ignore the timing of the expense and ask whether it would be deductible under normal rules.
Allowable expenses: revenue expenses
The general rule is that a deduction is allowed for expenses which are incurred wholly and exclusively for the purposes of the property rental business and which are revenue in nature. Expenses that will qualify for deduction are those that a landlord needs to incur in the day-to-day running of the property rental business, such as:
- interest on loans to buy the property (but not capital repayments);
- letting agents’ fees;
- accountants’ fees;
- utility bills;
- buildings and contents insurance;
- cleaning costs;
- costs of a gardener;
- telephone calls;
- stationery and postage;
- ground rent and service charges; and
-
council tax.
To the extent that expenses of this nature are incurred prior to the start of the business, they are deductible under the rules for pre-letting expenditure, as long as the expenditure is incurred no more than seven years before the start of the business.
Repairs vs improvements
The landlord may need to undertake repairs prior to letting the property. He may also carry out improvement works. It is important that the landlord is clear whether expenses relate to repairs (which are revenue and deductible under the pre-letting rules) or improvements, which constitute capital expenditure for which relief is given under the capital gains tax rules.
Broadly, expenditure on a like-for-like replacement would be a repair, whereas expenditure resulting in a significant upgrade would be an improvement.
Capital expenditure
Different rules apply to capital expenditure depending on whether the accounts are prepared under the cash basis or the accruals basis. The cash basis is the default basis where annual rental receipts are £150,000 or less; however, the landlord can elect to use the accruals basis. The accruals basis must be used where rental receipts are more than £150,000 a year.
Where capital expenditure would be deductible under the cash basis capital expenditure rules, any pre-commencement capital expenditure is likewise deductible and treated as if it had been incurred on the date that the property rental business commenced.
However, where the accruals basis is used, capital expenditure cannot be deducted. In limited circumstances, capital allowances may be available; where this is the case, capital allowances for pre-commencement capital expenditure are given as if the expenditure had been incurred on the day that the property rental business started.
Cost of the property
The cost of the actual property is not deductible under the pre-letting rules, regardless of whether the cash basis or the accruals basis is used.
Instead, the cost of the property, together with the associated costs of acquisition, such as stamp duty land tax and legal fees, are deducted as allowable expenses for capital gains tax purposes when working out the gain or loss when the property is eventually sold (or otherwise disposed).
Timing of relief
Pre-letting expenses are treated as if they were incurred on the first day of the property rental business and deducted together with other expenses incurred in that period in computing the profits of the property rental business.
Example 2: Pre-letting expenditure
Kevin buys a house in Manchester for £200,000 in January 2020. He pays stamp duty land tax of £6,000 and legal fees of £1,500.
Prior to letting, he decorates the property throughout (at a cost of £4,000) and converts the loft (at a cost of £40,000).
Kevin also incurs letting agents’ fees of £500 and spends £300 on buildings and contents insurance and a further £100 on telephone calls and stationery.
He lets the property on 1 August 2022, receiving six months’ rent in advance from the tenant on that date.
The property rental business commences on 1 August 2022.
Kevin can claim pre-letting relief for the following costs:
Redecoration costs £4,000
Letting agents’ fees £500
Buildings and contents insurance £300
Telephone and stationery £100
Total £4,900
The above expenses are treated as if they were incurred on 1 August 2022 and are deducted in computing profits for the property rental business for 2022/23.
The cost of the property and the associated legal fees and stamp duty, and the cost of the loft conversion are items of capital expenditure for which no deduction is available. Instead, they are taken into account for capital gains tax purposes in working out the capital gain or loss on the eventual disposal of the property.
Practical tip
Landlords often incur substantial expenses in getting a property ready to let. Failure to claim the allowable tax relief for these expenses can be an expensive oversight. Remember to keep detailed records of all pre-letting expenditure, together with invoices and receipts, so that nothing is overlooked.
