Meg Saksida looks at how landlords might be suffering in 2020/21 and how to deal with the tax effects of it.
The government’s advice is clear; landlords are not required to stop charging rent during the pandemic. Great efforts and huge financial grants have been made by the government to ensure that all tenants are able to pay their rent, including the furlough scheme for employees and the self-employment income support scheme for those running their own businesses.
In addition, tenants can contact their local council, to whom the government have made £500 million available to fund households experiencing financial hardship, and a further £180 million funding for discretionary housing payments to distribute to help tenants with rent payments. Finally, tenants falling into financial difficulties may also qualify for Universal Credits.
Rental reductions, rental holidays and tenants falling behind with their rent
In theory, therefore, no one should be in a position where they can’t pay their rent. However, everyone’s situation is different, and landlords may be asked either for a rental holiday or for a reduced rent for a period or even worse, may find that the rental payments simply stop or reduce.
The first step should always be a frank and open discussion between the landlord and the tenant, and the government has requested that landlords are flexible and understanding in these situations.
The taxation of the rental arrears, holidays and rent reductions, however, depends on whether the landlord uses the ‘cash basis’ or the ‘accruals basis’.
1. Cash basis
Most landlords will use the cash basis unless their rental income is over £150,000 or they opt for the accrual basis. The cash basis operates such that income is recognised when it is physically received, not accrued according to the contract, and expenses when they are physically paid, not incurred.
For example, if a landlord received £5,000 in his bank account in 2020/21 for rental income, this will be their income for taxation purposes. It will not matter if the rental contract specifies £7,000. Likewise, despite owing £800 in insurance, if the invoice had not been paid at the end of the year, it will not be tax deductible.
The cash basis has a built-in benefit when it comes to rental payment arrears and holidays, as bad debts are automatic in the mechanics of the cash basis.
Tenants falling behind
Only profits resulting from rental income that have been received are taxed; therefore, if the tenant is unable to pay the rent, the income will not be received and therefore, not taxed.
For example, if a landlord has a private house they are letting out for £24,000 a year, with £4,000 expenses, if the tenant falls behind with their rent and only pays £1,500 a month, only the income actually received will be taxed. Rather than the contracted amount of £24,000; because the landlord only received £18,000, they will therefore be taxed on only £14,000 (i.e. £18,000 less the £4,000 expenses).
Once the tenant’s situation improves (e.g. starting in May 2021), they start to pay £2,500 to make up for the previous arrears. Any rental income received will be taxed in the tax year in which it was actually received, in this case 2021/22.
The cash basis is advantageous as income due but not received is not taxable; but landlords must remember that once it is received it will be taxable in that tax year, so when arrears start to be paid back, the tax due in 2021/22 may end up being disproportionately larger than that of 2020/21.
Rental reductions and rental holidays
If the landlord decides to allow the tenant a rental holiday, or a temporary reduction in rent for which they will not seek repayment, as long as these amounts are not received, they are not chargeable to tax.
2. Accruals basis
Landlords will be required to use the accruals basis if their rental income is over £150,000 or their rental income is lower but they opt for the accrual basis. The accruals basis means the income is accounted for as it is due, not necessarily when it is received. The accruals basis operates such that income is recognised when it is accrued according to the contract, irrespective if it is received, and expenses when they are incurred whether they are paid out or not.
For example, if the rental contract states £7,000 is due in 2020/21 and the landlord only received £5,000 in his bank account, the landlord will still be taxed on £7,000. It will not matter how much was physically received. Likewise, if they owed £800 at the end of the tax year in insurance, even if the invoice had not been paid at the end of the year £800 would still be tax deductible.
Tenants falling behind
In our above example, the landlord was due to receive £2,000 a month, so they would have £24,000 as ‘income’ in their accounts. As well as the income, they will have an amount in the bank account which represents the amount the tenant has paid them of £18,000, and a ‘debtors’ amount to show what is still due or the amounts for which the tenant is in arrears (i.e. £6,000). Even though the full £24,000 has not been received, under the accruals method this will be taxable in 2020/21.
Eventually, if the tenant does not pay, this £6,000 due (taxed but not received) can be reclaimed as a bad debt; but in the meantime, this can be a significant cash flow disadvantage.
Rental reductions and rental holidays
If initially, the landlord was expecting the income, and subsequently decided to write off the income, a bad debt adjustment would be made, as explained above. However, if the decision was to write off or reduce future rental income, these amounts would simply not be included in income and debtors in the first place, and as a genuine debtor would not exist, the landlord will not be expecting the rental income.
If the lack of rental income means that the gross profits due to be taxed fall under £1,000, no tax return will be necessary. If the gross income falls to above £1,000 but below £10,000, and the profit is under £2,500, HMRC may be able to collect the tax on the income through the landlord’s PAYE code.
Making a loss as a result of rental income not being received
If rental income has been written off, is in arrears, or has reduced, whether the landlord is working under a cash or an accruals basis, a loss may arise. A loss arises when the rental income received is lower than the allowable deductions.
For tax purposes, a loss may only be offset in the tax year of the loss if a profit has been made on other rental income in the UK (including a furnished holiday let business). If no such profit exists, it must be carried forward to future years for offset.
Property businesses are split into UK property businesses for UK properties let and overseas property businesses for properties let that are situated abroad. Losses can only be offset against profits of the same kind of rental business, so a loss on an overseas property cannot be deducted from a profit on a UK one.
Practical tip
Where cash flow is important and rental income is not at the level where the accruals basis is required to be used, the cash basis allows immediate bad debt recovery for tax purposes. Where there is a rental holiday or rent reduction, or the tenant’s rent is in arrears, no tax payment is required on these unreceived amounts.
