Key points:
- Landlords can obtain relief for expenses incurred in getting the property ready to rent.
- To qualify for relief, the expenses must be incurred not more than seven years before start of the rental business.
- Relief is available for expenses that would have been deductible had they been incurred after the commencement of the rental business.
Landlords often incur significant time and money in getting properties ready to rent. A failure to claim the tax relief that is due in respect of pre-letting expenses can be a costly oversight. Pre-letting expenses are expenses which are incurred before the commencement of the property rental business.
Start of the rental business
In order to ascertain whether an expense was incurred before or after the start of the property rental business, it is necessary to establish the start date of that business. Where the business is the letting of property, the business starts with the let of the first property. The business begins when the landlord receives income from the property for the first time.
Under the rules for taxing income from property letting, all income and expenses from the letting of property in the UK (subject to special rules for furnished holiday lettings) by the same person or group of persons are grouped together to work out the profit or loss for that property rental business. Consequently, the business comes into existence with the first letting. The letting of any subsequent properties forms part of an existing business. This is important for determining whether expenses are incurred before or after the rental business commenced.
Pre-letting expenses
Expenditure is only pre-letting expenditure if it is incurred prior to the let of the first property. Expenses incurred in preparation to let second and subsequent properties which are incurred after the first property has been let are not pre-letting expenses. The business is in existence at this point and the expenses are expenses of the property rental business and can be deducted in accordance with the normal rules for deductibility of expenses.
Example 1 - Pre-letting expenses
Holly purchases two properties in 2012 which she plans to let out. She spends some time and money doing the properties up in preparation for letting. She lets the first property on 1 May 2013 and the second property on 16 September 2013.
The expenses incurred prior to 1 May 2013 in relation to both properties are pre-letting expenses. However, any expenses incurred on or after 1 May 2013 in getting the second property ready for letting are not pre-letting expenses. The property rental business comes into existence on that date, and any expenses subsequent to that date are expenses of an existing business, notwithstanding they may be incurred in relation to a property that has yet to be let.
Relief for pre-letting expenses
Relief for pre-letting expenses is given by reference to the rules that apply generally to pre-trading expenses incurred by businesses. For relief to be available, certain conditions must be met:
- the expenses must have been incurred not more than seven years before the start date of the business;
- no deduction is otherwise available for the expenses; but
- a deduction would have been given had the expenses been incurred once the business had started.
Consequently, in determining whether relief is available it is necessary to initially ignore the timing of the expense and ask whether it would be deductible under normal rules.
Allowable expenses
The general rule is that a deduction is allowed for expenses which are incurred wholly and exclusively for the purposes of the property rental business, and which are revenue in nature. Expenses that will qualify for deduction are those that a landlord needs to incur in the day-to-day running of the property rental business, such as:
- interest on loans to buy the property (but not capital repayments);
- letting agents’ fees;
- accountants’ fees;
- utility bills;
- buildings and contents insurance;
- cleaning costs;
- costs of a gardener;
- telephone calls;
- stationery and postage;
- ground rent and service charges; and
- council tax.
To the extent that expenses of this nature are incurred prior to the start of the business, they are deductible under the rules for pre-letting expenditure, as long as the expenditure is incurred no more than seven years before the start of the business.
Tip:
Keep a record of all expenses incurred prior to letting, so that relief can be claimed.
Pre-letting repairs
It often the case that the landlord will need to carry out repairs to a property prior to letting. These can be substantial.
Normal rules apply to determine whether or not repairs costs are deductible and a distinction is drawn between revenue expenditure, for which a deduction may be given, and capital expenditure, which is not deductible, but for which relief may be given in different ways.
A distinction is drawn between repairs and improvements. The cost of replacing like with like would be regarded as a repair for which a deduction is likely to be forthcoming. However, a significant upgrade is likely to be regarded as an improvement and treated as capital rather than revenue. That said, HMRC will accept that expenditure is revenue in nature where any improvement results solely from the use of new materials as long as these are the modern equivalents to those used originally. HMRC cite the following examples of common expenditure on repairs which would be allowable:
- exterior and interior painting and decorating;
- stone cleaning;
- damp and rot treatment;
- mending broken windows, furniture, and items such as cookers and lifts;
- re-pointing; and
- replacing roof slates, flashing and guttering.
To the extent that repairs of this nature are carried out before the start of the property rental business, the costs would be deductible under the pre-letting expenses rules.
A property may be bought in a dilapidated state with a view to doing it up prior to letting. The fact that the property was bought just before the repairs were undertaken does not in itself make the repair a capital expense, although HMRC will treat the expenditure as capital if:
- the property was not in a fit state for use until the repairs have been carried out;
- the price paid for the property was substantially reduced due to its dilapidated state; or
- the taxpayer enters into an agreement to reinstate the property to a good state of repair.
However, a deduction is not denied if the price reflects a reduced value arising from normal wear and tear.
The cost of improvements is taken into account for capital gains tax purposes when the property is sold.
Trap:
Don’t confuse improvements and repairs.
Cost of the property
Where a property is bought with a view to letting, no deduction is allowed for the cost of acquiring the property and associated fees such as stamp duty and legal fees. These are taken into account for capital gains tax purposes when the property is sold.
Timing of relief
Pre-letting expenses are treated as if they were incurred on the first day of the property rental business and deducted together with other expenses incurred in that period in computing the profits of the property rental business.
Example 2 – Relief for pre-letting expenses
Zac buys a house for £200,000 in January 2013. He pays stamp duty of £2,000 and legal fees of £1,500. Prior to letting he decorates the property throughout (at a cost of £4,000) and adds a conservatory (at a cost of £15,000). He also incurs letting agents’ fees of £500 and spends £300 on buildings and contents insurance and a further £100 on telephone calls and stationery. He lets the property on 1 August 2013, receiving six months’ rent in advance from the tenant on that date.
The property rental business commences on 1 August 2013. He is able to claim pre-letting relief for the following costs:
Redecoration costs £4,000
Letting agents’ fees £500
Buildings and contents insurance £300
Telephone and stationery £100
Total £4,900
The expenses are treated as if they were incurred on 1 August 2013, and are deducted in computing profits of the property rental business for the first period.
The cost of the property, the associated legal fees and stamp duty and the cost of the conservatory are items of capital expenditure for which no deduction is available. Instead they are taken into account for capital gains tax purposes.
Practical Tip:
Landlords often incur substantial expenses in getting a property ready to let. Keep a record of these expenses, and remember to claim a deduction for all allowable pre-letting expenses.
