James Bailey explains when and if deposits received from tenants should be recognised as income of a property letting business.
It is the usual practice to require a tenant to pay a deposit to the landlord when moving into a property. At the end of the tenancy, the deposit is returned, subject to deductions for ‘dilapidations’.
Tenants are normally responsible for maintaining and repairing the interior of the property, and if at the end of the tenancy they have failed to do so then the tenant and the landlord will negotiate how the situation is to be dealt with.
Normally, the negotiation will take the form of agreeing how much of the deposit is to be returned to the tenant, with the balance retained by the landlord to cover the cost of the dilapidations.
Deposit schemes
In the case of assured shorthold residential tenancies, with very few exceptions, the treatment of the deposits paid by tenants is governed by statute. The landlord is required to protect the tenant’s deposit by using one of two types of government approved ‘deposit protection schemes’.
In a custodial scheme, the deposit is paid to the scheme, and at the end of the tenancy the deposit is returned to the tenant – subject to some or all of it being paid to the landlord to cover dilapidations.
In an insured scheme, the landlord retains the deposit, but pays insurance premiums to the scheme to protect the tenant’s interests.
Tax treatment
The tax treatment of deposits for landlords follows the normal principles of accountancy. When the tenant moves in and pays his deposit, the landlord has no right to the deposit money. He only becomes entitled to some or all of it at the end of the tenancy, when he may be allowed to retain part or all of the deposit to cover dilapidations.
Deposits received are income of the landlord’s property business, but this income should be ‘deferred’ until the end of the tenancy. The principle of ‘deferred’ income applies where the recipient of the income has not done whatever is required to ‘earn’ that income. In the case of a landlord, the deferral will continue until the landlord acquires (by agreement with the tenant or in cases of dispute, by the intervention of the Deposit Protection Service) the right to retain some or all of the deposit to cover dilapidations – or possibly, unpaid rent. At that point, the amount of the deposit retained is brought in as income, and the cost of making good the dilapidations is an expense.
This applies whether or not the landlord re-lets the property. Even if the landlord moves into it himself or sells it untenanted, the deposit was income (albeit deferred income) when he received it and it does not change its character as a result of him deciding not to re-let the property.
It should be noted that if the cost of the dilapidations is greater than the deposit, and if the tenant pays the landlord compensation for them in addition to forfeiting all the deposit, the tax treatment is different if the property is not re-let. In that case, the additional payment is likely to be treated as a capital receipt (giving rise to a capital gain), because it is compensation for the reduced value of the property as a result of the dilapidations. If the property is re-let, then the additional sum paid is treated as income and the cost of making good the dilapidations is an expense.
Practical Tip:
Make sure you do not include deposits as part of the income of your property business until the end of the tenancy concerned, and then only to the extent that you do not return the deposit to the tenant.
