Alan Pink looks at a case study involving the landlord of houses in multiple occupation.
HMO stands for house in multiple occupation. We’ve always had these in the UK, but they seem to be a very topical subject at the moment, no doubt due to our chronic housing shortage.
The experience of landlords letting HMOs seems to vary, with some enjoying greatly enhanced profits from this manner of exploitation of their property, and others tearing their hair out with the administrative hassle. It seems to be something of a specialist area letting HMOs.
Tax and HMOs
Given the crying need for this sort of accommodation in our arguably overcrowded island, what tax breaks does the government give to HMO landlords?
As far as direct tax is concerned, it would probably be fair to answer that question with ‘none at all’. For example, the dreaded ‘Osborne tax’ (i.e. the phased reduction in relief for interest paid on loans) applies just as much to HMO letting as to any other kind of residential letting.
As far as the costs of conversion are concerned, to make a property suitable for HMO use, these will mostly be non-allowable against rents received on the grounds that they are ‘capital’ expenditure. True, such expenditure, if carefully recorded and the records kept until sale, will qualify for relief in computing any capital gain on sale of the property. But as far as immediate tax relief is concerned, landlords are effectively restricted to claiming relief for some redecoration/refurbishment type expenditure, normally where they have already owned the property, and let it out for a period prior to the conversion. In that instance, such expenditure should clearly be separated out from the heavier conversion work, and the amounts claimed separately.
VAT
It’s really in the area of VAT, rather than direct tax, where there are solid and identifiable tax breaks, and I’d like to bring these out by way of a case study.
Case study: Which VAT rate?
Albert is a great believer in HMOs as a business, and he has recently acquired two fairly rundown houses with a view to maximising their rental potential through HMO letting.
The house in Waterloo Road was actually already let as an HMO at some point in its past, to judge by the rudimentary adaptations to the fabric which Albert finds on surveying the property. He intends, though, to convert it into two multiple occupancy flats because it is a substantial Victorian property and he considers that the space can be more efficiently used in this way and, importantly, the rents maximised by creating smaller and therefore ‘cosier’ units.
Albert’s other property, in Blenheim Terrace, is much smaller and he decides to convert it from the current design as an ordinary house into a HMO.
Albert successfully completes the purchase of the two houses and uses the same building contractor, Dodge Property Development Limited, to do the conversion. The cost for the large house at Waterloo Road is agreed at £200,000 plus VAT, and that for Blenheim Terrace at £100,000 plus VAT.
Then, someone points out to Albert that there’s a VAT break for converting houses into HMOs. Albert looks on the internet and sees that the rate of tax for qualifying conversions is 5%, rather than the normal standard VAT rate of 20%. Naively, he decides to write to HMRC, enclosing the invoices from Dodge Property Development Limited which he has received so far, and claiming a refund of the difference between the 20% which the builders have charged and the 5% that is due.
This request gets short thrift from the VAT officer. He points out that the way this relief generally works is that the development company should only be charging 5% VAT in the first place. The invoices that have been raised so far need to be made the subject of a ‘VAT only’ credit note, reducing the VAT charge from 20% to 5%. Albert goes back to the managing director of Dodge, who says that he needs to check with his accountant. In the meantime, the invoices keep coming and Albert, trustingly, keeps paying them.
At long last, the advice comes back from Mr Dodge’s accountant, who points out that the property must not only be ‘designed’ for use by more than one household following the conversion but that there must have been no such dwellings in the property prior to the conversion. So, unfortunately, the property in Waterloo Road doesn’t qualify for the VAT reduction because, even though it hasn’t actually been used as an HMO in the immediate past, it is designed as such, and therefore the conversion doesn’t fit within the exact terms of the relief.
However, the accountant goes on, this isn’t the case with the property at Blenheim Terrace and, therefore, the VAT of £20,000 that has been charged on the £100,000 conversion costs needs to be reduced to £5,000 by the issue of a £15,000 VAT only credit note.
When Albert calls up Mr Dodge to ask for the refund of his £15,000, he gets a continuous tone…
Tax planning points
A 5% reduced rate of VAT is available both for HMO conversions and for ‘changed number of dwellings’ conversions. The latter category does almost exactly what it says on the tin; where there is a different number of dwellings in a property after a conversion as before (and this number can include zero, both before and after), the work done by the builder, and the materials supplied along with these building services, can be made subject to the reduced 5% rate.
However, there is a definite procedure for taking advantage of this reduced rate, which is ensuring that the building contractor charges the correct rate of VAT in the first place. HMRC will not intervene to put things right if an excessive rate of VAT is being charged.
So, the essential thing is to get this very clear, if at all possible, at the initial contract stage, and before the builder goes on site. This will sometimes involve reference to accountants or tax advisers on both sides, and it has to be remembered that the person who is vulnerable, if a 5% rate is applied when the strict criteria didn’t apply, is the builder.
For example, in our case study, if the accountant had missed the point that there was already HMO use in the Waterloo Road property’s history, and had issued the credit note, the builder would have been vulnerable to an assessment raised by any visiting VAT officer to levy the extra £30,000 that the builder had wrongly credited.
