Doing Up a Property Before You Let?

It may be a sweeping generalisation to say that HMRC seems to think that pre-letting expenses are a ‘happy hunting ground’ for denying tax claims, but even so, taxpayers’ claims are frequently challenged.  

This article aims to help landlords to put together valid claims, and highlight the points to look out for – and what to avoid. 

There are those who believe that there can be no tax relief for expenses incurred before the property letting business commences. They are wrong.

The legislation specifically provides for a deduction (in Income Tax (Trading and Other Income) Act 2005 (‘ITTOIA 2005’) s 57), which says that, in the absence of other relief:

Do not be put off by the fact that this section refers to ‘trades’ rather than property businesses: another part of the legislation (s 272) later on explicitly provides that the section applies just as well for letting. HMRC’s Property Income Manual confirms the treatment, at PIM2505 (www.hmrc.gov.uk/manuals/pimmanual/PIM2505.htm%20).

The expenses are aggregated and claimed alongside normal letting expenses, as soon as the property business starts. Just as with normal expenses incurred in the ongoing business, they can reduce net profits, or create (or enhance) a net loss.

No. The test is basically the same for pre-letting expenses as it is for ongoing business expenses. By far the most common reason for rejecting a claim is because it is a ‘capital expense’ – in other words, the expenditure has a long-term benefit for the business. Where there is a long-term benefit, there is normally no tax relief.

HMRC frequently argues with taxpayers and their advisers about whether or not something amounts to capital expenditure, and it is not always a straightforward issue. But a good example of a capital item is a loft conversion. By contrast, roof repairs to residential properties are not capital, but are fully allowable.

When trying to work out if an expense is capital, or allowable against profits from a property business, consider:

If the answer to any of these questions is ‘yes’ then the expenditure is almost certainly capital, and cannot be claimed as a deduction from rental income.

By contrast, recurring expenses – decorating, gas-safe certificate or maintenance – will normally be tax deductible, whenever they are incurred.

We have emphasised that the property’s value must be significantly affected: it is perfectly in order for a property to be discounted a little merely to reflect where it stands in its normal maintenance cycle – that will not turn the repairs into disallowable capital.

When evaluating whether or not the replacement (e.g., kitchen, bathroom) is an improvement on the original, compare it to when the original was brand new, not the state it was in when you bought the property. 

Don’t fall into the trap of thinking that an expense must be allowable for tax purposes, just because it is essential. For instance, some types of let property require fire doors, which are significantly more expensive than normal interior doors. Their installation might be a legal requirement, but they are also a significant improvement on the original standard door and, as such, will be capital. 

Likewise, beware the argument that the work was required in order to make the property fit for letting, or letting at a premium: HMRC will seize on this as evidence that there was a tangible and enduring benefit to the business – in other words it was a capital item.  

There is an argument that the only reason why any expense is incurred is to benefit the business – otherwise, you’d keep your money in your pocket. But for how long will the benefit last? Many landlords would argue that a property needs to be put (and maintained) in good condition, in order to secure a decent return. Decorating a house from top to bottom can cost thousands of pounds but it needs to be done every few years in order to keep the property in good order. The same broadly applies to any maintenance and repair work, including new roofs, kitchens and bathrooms: all of these things will eventually need to be replaced. The only thing to watch out for is improvements over the original when it was new, which will turn an allowable repair into a disallowed capital expense.

So recurring expenditure should be deductible, but something that will last indefinitely, like an extension, will be capital and therefore disallowed.

This is a trick question – and it catches out even experienced tax advisers. Remember that there is basically only one property business, no matter how many properties there are (ignoring special furnished holiday lettings and overseas properties). The property business will start when the first property is let. After that, any new properties only add to the existing business – so any expenses incurred on further properties before letting them out can be claimed immediately, without having to wait for them to be let.

Improvements don’t necessarily turn all refurbishment costs into disallowed capital expenditure. Adding a downstairs cloakroom will be an improvement and capital, but if the property has also been decorated throughout, the decoration expenses should still be allowed (although decorating the new cloakroom itself would be part of the capital improvements – disallowable).

Likewise, if fitting a new kitchen to replace existing of a similar quality but you add a dishwasher and an extra cupboard: you cannot claim for the extra cupboard or the new dishwasher but the rest should be allowed. 

Adding an extra kitchen unit is only an improvement as far as that single unit is concerned but if all of the replacement units are of a better quality than the originals (when the originals were brand new), then all of the units will be a capital improvement and the cost disallowed in full. 

It may be helpful to keep correspondence which values the property – and the projected rental yield – before and after the works: as long as there is no significant increase, it will be good evidence that the expenditure is not a capital improvement. Photographs may also help to demonstrate the quality of the property beforehand.

One final point: if you’re thinking of moving out of your own home and letting it out, HMRC will frequently claim that expenses incurred before first let should be considered private. Practically, it will be easier to claim for refurbishing that property during a letting period or between lets – particularly if there’s a chance you might re-occupy later on.