In his fourth article in the series, Lee Sharpe looks at repair work undertaken in a void period and how to deal with insurance claims.
The previous case study focused on the kind of expenses incurred when a landlord or landlady takes on a new property and prepares it for letting out.
This article considers a property that has been part of a landlord’s portfolio for some time but needs substantial remedial work following a long period of letting, and how to deal with insurance claims (i.e. both as contributions towards repair costs and for lost rents).
Case study 4: Preparing to re-let a property
Nadia has a portfolio of several houses, which she lets on a long-term basis. One of her older tenants has been ill for several years; as the tenant preferred not to be disturbed, the property was left untouched during that time. The tenant ultimately moved to sheltered accommodation, and Nadia is looking to put the property back into shape for re-letting.
Deductibility in a void period
It is quite difficult to make significant repairs to a property while it is occupied by tenants. HMRC accepts this and states in its Property Income manual at PIM2510: ‘You may also accept that the business has not ceased [and repairs may therefore be deductible] in cases where the property is temporarily unavailable while work on repairs or alterations is carried out’.
Note, however, that this may not apply where the property business has ceased or the specific property in question has been withdrawn from the property business, (say) to be sold or occupied privately.
Assessment
Insurance claim(s)
Aside from the repair work making the property unlettable for longer than usual, the builder recommends that the internal brick be left exposed for several weeks prior to completing the re-plastering, as not doing so could result in the plaster failing to bond and the risk of mould. This, in turn, means that the property will be vacant or ‘void’ for (say) six weeks instead of two or three weeks as normal.
While Nadia was expecting to lose a few weeks’ rent as ‘par for the course’ while making good, she also decides to claim for the lost rental income that she determines is attributable to the additional time cost of the extensive repairs required to remedy the damage done by the leak.
The claims assessor has no issue with the cost of the repair to the water damage per se, but the insurer insists that it is not liable to the extent that cost and repair time could have been mitigated if dealt with in a reasonable timeframe. Nadia faces something of a dilemma; under the terms of the letting agreement she could, in theory, claim against the former tenant for not having notified Nadia of the leak in good time. But she feels that suing a chronically ill pensioner, who had otherwise been a good tenant for many years, is unlikely to work wonders for her karma or bank balance.
In the end, she agrees a compromise with the insurance company; they will pay £6,000 towards the cost of the leak repairs and £1,000 towards Nadia’s lost rents – a total of £7,000.
Insurance for loss of rents
HMRC accepts that this is a valid business risk, as well as standard insurance that covers damage to the property and/or its contents (see HMRC’s Property Income manual at PIM2068). Premium payments will be allowable as incurred (note, however, that in this context eligible policies cover the risk of the loss of income specific to one’s property business, as distinct from a type of policy that covers the proprietor for a loss of his or her own personal income, e.g. income protection or ‘permanent health insurance’).
It logically follows that proceeds from an expense incurred to make good a ‘hole in one’s profits’ are also taxable. In terms of accounting for the proceeds of a claim for lost profits, Nadia will merely add £1,000 to her rental income for the year.
Insurance for repair costs
While the usual approach is merely to net the insurance claim proceeds against the repair costs, it is also acceptable to treat the two amounts separately; the end result should effectively be the same:
In A, the proceeds of the claim for repair costs are netted against the costs themselves, and the ‘real’ cost of the repairs to Nadia is shown in the accounts, as £12,000.
In B, the proceeds of the repair claim are aggregated with other income (as in A) and treated as part of gross income to the business. The net profit remains the same in either case.
While A might seem more logical, at least where the claim, repairs and proceeds all arise in the same reporting period, HMRC is equally happy for accounts and returns to adopt either approach, as per its Property Income manual at PIM2020: “Sometimes this is achieved in accounts by deducting the expense when it is incurred, and crediting the insurance recovery as a receipt when it is received. You may accept this approach.”
Route B is more commonly encountered in cases where the expenses are incurred in one (or more) chargeable period, and the proceeds are received in a later period.
Other expenses
Replacing furniture should be tax-allowable as part of the cost of replacing domestic items in a residential letting.
The new boiler may be superior to the previous installation, but so long as it is not a substantively superior marque when compared to its predecessor, the ‘improvement’ will be attributable to advances in technology, rather than Nadia’s deliberately choosing a ‘better’ boiler.
Replacing skirting boards, etc., would also be deductible under general ‘wear and tear’ (not the formal ‘wear and tear allowance’ of course, which was withdrawn in April 2016).
Given that no part of the works is attributable to improvements, there will be no need to split painting and decorating costs between that which is allowable now against rental income and that which is allowable only when the property is sold, under the capital gains tax rules.
Note: These points have been covered in greater length in previous case studies.
Conclusion
Nadia can claim for the costs of maintaining the property (and other costs, such as Council tax, mortgage interest, etc.) while the property is vacant, so long as the property is still part of her letting business; essentially, her intention is that it will be let again afterwards. She can also claim for her insurance costs to protect against damage to the property or loss of rental income.
