Making The Most Of Your Spare Room

Sarah Laing CTA looks at how you can make some extra tax-free income from renting out a room in your home.

The tax rules for renting out a room in your home are different to those for renting out a property. The ‘rent-a-room’ scheme is an optional exemption scheme that lets people receive £4,250 of tax-free gross income (income before expenses) from renting out spare rooms in their only or main home.

Accommodation

The accommodation has to be furnished and a lodger can occupy a single room or an entire floor of the house. However, the scheme doesn’t apply if the house is converted into separate flats that are rented out. Nor does the scheme apply to let unfurnished accommodation in your home.

The rent-a-room tax break does not apply where part of a home is let as an office or other business premises. The relief only covers the circumstance where payments are made for the use of living accommodation.

Additional services

If additional services are provided (cleaning and laundry etc), the payments must be added to the rent to work out the total receipts. If income exceeds £4,250 a year in total, a liability to tax will arise, even if the rent is less than that.

There are two options if you’re receiving more than £4,250 a year:

the first £4,250 is counted as the tax-free allowance, and income tax is paid on the remaining income; or
renting the room is treated as a normal rental business, working out a profit and loss account using the normal income and expenditure rules.

In most cases, the first option will be more advantageous.

Advantages v disadvantages

The principal point to bear in mind is that those using the rent-a-room scheme cannot claim any expenses relating to the letting (eg insurance, repairs, heating).

To work out whether it is preferable to join the scheme or declare all of the letting income and claiming expenses via self-assessment, the following methods of calculation need to be compared:

Method A: paying tax on the profit they make from letting worked out in the normal way for a rental business (ie rents received less expenses); or
Method B: paying tax on the gross amount of their receipts (including receipts for any related services they provide) less the £4,250 exemption limit.

Method A applies automatically unless the taxpayer tells their tax office within the time limit that they want to use method B.

Once a taxpayer has elected for method B, it continues to apply in the future until they tell HMRC they want to use method A. The taxpayer may want to switch methods where the taxable profit is less under method A, or where expenses are more than the rents (so there is a loss).

Example – Which method should be used?

James

James has gross receipts of £5,000 and expenses are £6,000, so he has a loss of £1,000. Unless he opts out of method B, he will be taxed on the excess of the gross receipts of £5,000 over the exemption limit of £4,250, so he will be taxed on a profit of £750.

Fred

Fred’s gross receipts for the year are £5,200. His expenses are £1,000 so his net profit is £4,200. The excess of his receipts over £4,250 is £950 (£5,200 less £4,250).

Using method A, he pays tax on his actual profit of £4,200.

Using method B, he pays tax on a profit of £950.

Fred should make an election to use method B.

Practical Tip :

You have up to one year after the end of the tax year when your income from lodgers went over £4,250 to decide the best option to take, so take the time to work out which route produces the lowest tax bill.