£8,500 Rental Income – Tax-Free!

Sarah Bradford explores how it is possible to enjoy a rental income of £8,500 tax-free and to benefit from both rent-a-room relief and the new property allowance.

The tax system contains various allowances, and as long as the income does not exceed the allowance, there is often no need to tell HMRC about the income. The amounts involved are generally small and the loss of any associated tax is likely to be outweighed by the costs of collection. The allowances are, however, good news for taxpayers, as they provide the opportunity for tax-free income. 

As far as property taxes are concerned, the rent-a-room scheme and the new property allowance provide the opportunity for tax-free property income.

The rent-a-room scheme provides a tax incentive for homeowners with a spare room to take in a lodger. The aim of the scheme is to increase the supply of longer-term lettings.

Under the scheme, an individual can generate up to £7,500 tax-free per tax year from letting out furnished accommodation in their own home. The home does not have to be owned – the scheme also applies to rented properties. Where the property is owned (or rented) with one or more other people, the rent-a-room limit is halved, so that each person can receive rental income of up to £3,750 tax-free. The relief is also available to those running a bed and breakfast or a guest house. However, it cannot be used where a property has been converted into separate flats. 

The rent-a-room exemption is automatic. So, if an individual lets furnished accommodation in their own home and the rental income they receive is less than the rent-a-room limit (£7,500 for one person, or £3,750 for two or more), they do not need to tell HMRC about that income. They simply opt into the rent-a-room scheme when completing their tax return.

Where the rental income is more than the rent-a-room limit, there is a choice to be made. The individual can opt into the rent-a-room scheme and pay tax on the rental income in excess of the rent-a-room limit. Alternatively, they can calculate their profits in the normal way – by deducting expenses from the rental income. It is up to the individual to choose which route to go down. Where actual expenses are less than the available rent-a-room allowance, opting into the rent-a-room scheme will provide the best result (i.e. the lowest tax bill). By contrast, if the actual expenses are more than the available rent-a-room allowance, it is better to work out profits in the usual way.

Rent-a-room will not always be beneficial, even if the rental income is below the allowance. If actual expenses exceed the rental income (so there is a loss), it is better to work out profits in the usual way so as to preserve the loss.

Individual landlords are able to benefit from a new £1,000 allowance for property income from 6 April 2017 onwards. The allowance applies to income from a property rental business (i.e. one that is chargeable under ITTOIA 2005, Pt 3). However, it does not apply to partnership property income. 

The allowance allows individuals to ignore small amounts of property income for tax purposes. The allowance applies automatically, and where the relevant property income is less than £1,000 there is no tax to pay and HMRC do not need to be told about the income. 

Where relevant property income is more than £1,000, as with rent-a-room income the individual has a choice. An individual can make a claim for partial relief. The effect of such as claim is that the taxable profit is found by deducting the £1,000 allowance from the actual rental income, such that the individual pays tax on their rental income to the extent that it exceeds £1,000.

This may or may not be the best option. 

If the actual expenses are less than £1,000, claiming partial relief will give the best result. However, if actual expenses are more than £1,000, a claim for partial relief will not be beneficial – calculating the rental profit in the normal way will result in a lower tax bill.

The allowance can be used against a UK or an overseas property business, or both. Where an individual has both a UK and an overseas property business, they can choose how to allocate the allowance between them. 

Where relevant property income is less than £1,000, the default provision is for full relief to be given. The effect of this is that the income and expenses are not brought into account in calculating the profits or losses of the property business – the property business is treated as if it has made a profit of nil. This will not always be beneficial, as if the property business makes a loss the benefit of that loss will be lost. The legislation contains an option to elect for full relief not to apply. Making such an election will allow a loss to be preserved and carried forward for set-off against any future profits of the property rental business.

The rent-a-room allowance can only be used for lettings that qualify for the scheme – namely the letting of furnished accommodation in the individual’s own home (including where the individual is running a bed-and-breakfast or a guest house). By contrast, the property allowance cannot be used against income that qualifies for the rent-a-room scheme. 

This means that setting both against the same income is not permitted (so an individual cannot receive £8,500 from letting out his spare room). But that does not mean that an individual cannot enjoy both allowances.

…or both

It is possible to take advantage of both rent-a-room and the property allowance to enjoy tax-free property income of up to £8,500 per tax year – as long as the individual has more than one property rental income stream. So, an individual who lets out a room in their home, and, say a buy-to-let property, can claim both rent-a-room relief and the property allowance.

Joanna works full time as a beauty therapist, earning £18,000 a year. To gain some extra money, she lets her spare room to a lodger, earning rental income of £8,000 a year. She also has a beach hut, which she rents out in the summer, earning £900 in 2017/18.

Her personal allowance is utilised against her income from her job.

She opts into the rent-a-room scheme and receives £7,500 of the rental income from her lodger tax-free, paying tax on the balance of £500.

As the income from letting out her beach hut is less than £1,000, the property allowance is available automatically. She receives the income tax-free, and does not need to declare it on her tax return.

Joanna is able to benefit from both rent-a-room relief and the property allowance and enjoys tax-free property income of £8,400.

By having more than one rental income stream, it is possible to take advantage of both rent-a-room relief and the property allowance and enjoy tax-free property income of up to £8,500 per tax year.