Sarah Bradford explains how landlords using the accruals basis can obtain relief for capital expenditure.
Although the cash basis is the default basis of accounts preparation for most landlords with rental income of £150,000 a year or less, some landlords continue to prepare their accounts using the accruals basis. This may be because they do not qualify for the cash basis, as would be the case if their annual rental income is more than £150,000, or because they simply choose to prepare accounts using the accruals basis.
The rules for obtaining relief for capital expenditure differ depending on the way in which the accounts are prepared. Where the accruals basis is used, capital expenditure cannot be deducted in calculating profits, as is the case for certain types of capital expenditure where the cash basis is used. This is subject to an exception for the cost of replacement of domestic items in furnished lets. Instead, to the extent that relief for capital expenditure is available, this is obtained either through the capital allowances system or as a deduction when calculating any capital gain or loss on the disposal of the property.
Capital allowances
A property rental business may be able to claim capital allowances. Depending on the type of building, structures and building allowance may also be available.
For the purposes of the capital allowances legislation, the following count as qualifying activities:
- UK property businesses;
- overseas property businesses; and
- furnished holiday lettings, both in the UK and the EEA.
As a result, landlords may be able to claim capital allowances in respect of certain types of capital expenditure.
Plant and machinery allowances
Plant and machinery capital allowances are available for expenditure on items that fall within the meaning of ‘plant and machinery’ for the purposes of the capital allowances legislation.
It will be fairly clear whether an item is an item of machinery, and expenditure on vehicles and computers will fall within this category. However, it will not always be clear cut whether something counts as ‘plant’. HMRC guidance lists the following characteristics of ‘plant’ which have been derived from case law:
- It is the apparatus used for carrying on the business (‘the tools of the trade’).
- It is not stock in trade.
-
It is kept for permanent employment in the business.
A distinction is drawn between the apparatus used to carry on the business and the setting in which it is carried on – the latter not counting as plant. Consequently, plant and machinery capital allowances cannot be claimed for the property itself (although certain non-residential buildings may qualify for structures and buildings allowance).
It should be noted that unless the business is a furnished holiday lettings (FHL) business, capital allowances cannot be claimed on furniture and furnishings. However, FHL businesses are able to claim capital allowances, including the annual investment allowance, for furniture and furnishing. As the costs of these can mount up, particularly if the landlord has several furnished holiday lets, it is important that this is not overlooked.
For landlords running property rental businesses, the most likely capital allowance claims will be for items such as vehicles used in the business and for office equipment, such as computers. Capital allowances can be claimed for cars only if mileage allowances are not claimed using the simplified expenses system and, unlike vans, do not qualify for the annual investment allowance (AIA). Where the vehicle is used both for the business and privately, the allowances must be apportioned and relief only claimed to the extent that the vehicle is used for the business.
The AIA provides 100% relief against profits in the tax year in which the expenditure was incurred. Claims for the AIA should be made where possible; expenditure on vans and computers would, for example, qualify.
Where the business is operated through a company, enhanced capital allowances in the form of a ‘super-deduction’ may be available where the expenditure is incurred between 1 April 2021 and 31 March 2023, giving immediate relief for 130% of the expenditure where it would otherwise qualify for main rate capital allowances.
Structures and buildings allowance
Structures and buildings allowance is available in respect of qualifying non-residential buildings and structures which are used for a qualifying activity. This includes use as a UK or overseas property business other than for use as residential or FHLs. Consequently, landlords buying commercial properties which they rent out may qualify.
The allowance is given on a straight-line basis at the rate of 3% (giving a claim period of 33 1/3 years). The claim is made in the tax return.
However, if the structure or building is sold, there may be more CGT to pay as the allowances claimed are added to the disposal receipts, increasing the gain (or reducing the loss). In light of this, eligible landlords should assess whether a claim is worthwhile. This will depend on their marginal rate of tax and whether they plan to sell the building.
Relief for the cost of furniture and furnishing
The way in which relief is given for the cost of furniture and furnishing depends on the type of let.
As noted above, where a furnished property is let as a FHL, capital allowances are available. However, where the business is a property rental business, the landlord is not able to claim capital allowances for furniture and furnishings. No relief is available for the costs of these when purchased; instead, relief is available, as a deduction in computing profits, when the items are replaced (provided that the associated conditions are met).
To qualify for a deduction for the cost of replacement domestic items, the following conditions must be met:
- The individual or company claiming the relief must carry on a property business that includes the letting of a dwelling house (or houses).
- An old domestic item that has been provided for use in the dwelling house is replaced with the purchase of a new domestic item. The new item must be provided for the exclusive use of the lessee in the property and the old item must no longer be available for their use.
- A deduction for the item must not be prohibited by the ‘wholly and exclusively’ rule (which limits a deduction to items used wholly and exclusively for the purposes of the business), but a deduction must otherwise be prohibited by the capital expenditure rule (to ensure that a deduction is not given twice for the same expenditure).
-
Capital allowances must not have been claimed on the new domestic item.
Relief under these rules is not available where rent-a-room relief has been claimed.
Relief is given for the cost of the replacement item, plus costs of acquisition of the new item (e.g., delivery) and the disposal of the old item, less any proceeds received from the sale of the old item. The relief is given as a deduction in computing profits.
Cost of building and improvements
Unless structures and buildings allowance is available, relief for the cost of property and any subsequent improvements, such as extensions or new bathrooms and kitchens, is given when the property is sold in computing the gain or loss on disposal. The cost of the property and of any improvements and the costs of acquisition (e.g., SDLT and legal fees) are deducted from the sale proceeds, along with the costs of disposal (e.g., estate agent and legal fees) to work out the gain or loss on disposal.
Where a landlord sells a residential property realising a gain, this should be reported to HMRC within 60 days of the completion date. A payment on account of the CGT due on the gain should be paid within the same time frame.
Practical tip
If you prepare accounts for your property business using the accruals basis, make sure you understand the rules for obtaining tax relief for capital expenditure, and that you claim the appropriate relief where available. Keep records of your expenditure and receipts and invoices to substantiate your claim.
