Sarah Bradford looks at rent-a-room relief and asks if a claim is always worthwhile.
Rent-a-room relief enables an individual to earn up to £7,500 a year tax-free from letting out a furnished room or rooms in their home. They do not need to be a homeowner to benefit – the relief is also available for letting out rooms in a rental property (although the landlord's consent may be needed to sublet).
The relief is valuable; everyone can benefit, regardless of the rate at which they pay tax. It is worth up to £1,500 for a basic rate taxpayer, £3,000 for a higher rate taxpayer and £3,385 for an additional rate taxpayer. However, a claim will not always be beneficial.
Overview of the scheme
The rent-a-room scheme was introduced to encourage people to let out spare rooms in their home to increase the supply of private rented accommodation. In return, they were able to earn tax-free income of up to £7,500 a year. This limit is halved where the income is shared by two or more people so that each person can earn up to £3,750 per year tax-free.
The scheme can be used where a furnished room is let to a lodger. It can also be used by those running a bed-and-breakfast or a guest house where the letting amounts to a trade.
However, the scheme cannot be used if:
- the room which is let is not part of the individual's main home when let;
- the room is let unfurnished;
-
the room is used as an office or for the purposes of a business.
However, where the room is let to a student, study facilities can be provided. Likewise, the scheme remains available if a lodger works in the room in an evening or at weekends.
The way the scheme works depends on the gross rental income received in the tax year.
Rental income less than the rent-a-room limit.
Rent a room relief applies automatically where the gross rental receipts are less than the relevant rent a room threshold (£7,500 where rental income is received by one person or £3,750 per person where the rental income is received by more than one person). Where this is the case, HMRC does not need to be told about the rental income, which is tax-free in the hands of the recipient.
The gross rental receipts are those for the tax year in question and include rental income before the deduction of expenses plus any amounts received for the provision of services, such as meals and laundry. Any balancing charges that arise on the disposal of assets on which capital allowances have been claimed are also taken into account in the calculation of gross rental receipts.
Where the letting activity amounts to a trade, as would be the case for a bed-and-breakfast or a guest house, the gross receipts are those for the basis period for the tax year in question. Where the trade is established, this will be the receipts of the period of account which ends in the relevant tax year.
Example 1: Rental income below tax-free limit
Rose lets out her spare room furnished for £500 a month. Her annual rental income is £6,000.
As this is less than the rent-a-room limit of £7,500, the relief applies automatically. She receives the rental income tax-free and does not need to report it to HMRC.
Rental receipts exceeding the rent-a-room limit
Individuals with rental income of more than the rent-a-room limit from letting furnished accommodation in their home can still benefit from rent-a-room relief. Alternatively, they can choose to work out their taxable rental profit in the usual way.
In each case, they will need to complete the property income pages of their self-assessment tax return and report the income to HMRC.
If they choose to take advantage of rent-a-room relief, the taxable amount is simply the amount by which their gross rental receipts exceed the rent-a-room limit. If the taxpayer wishes to use this method, they must elect to do so. Capital allowances cannot be claimed if the rent-a-room scheme is used.
The rent-a-room scheme will be advantageous where the threshold is more than the actual expenses.
Example 2: Rental income above rent-a-room limit
Lily lets out two rooms in her home. Both are furnished. Her gross rental receipts in the tax year are £8,250. Her expenses in the year are £600.
She opts to take advantage of the rent-a-room scheme, electing to do so in her tax return. Her taxable profit is £750 (i.e. £8,250 - £7,500).
Had she not opted to use the rent-a-room scheme, her taxable profit would have been £7,650; her rental income of £8,250, less her actual expenses of £600. Opting to use the rent-a-room scheme reduces her taxable profit by £6,900 (i.e. £7,650 - £750), saving her tax of £1,380 (i.e. £6,900 @ 20%) if she is a basic rate taxpayer and £2,760 (i.e. £6,900 @ 40%) if she is a higher rate taxpayer.
Using the rent-a-room scheme will not be beneficial if actual expenses plus any available capital allowances are more than the rent-a-room threshold. Where this is the case, the taxable rental profit (and thus the associated tax bill) will be lower if the profit is computed in the usual way.
Example 3: Rent-a-room relief not claimed
Violet runs a bed-and-breakfast in a coastal resort. Her gross rental receipts for the tax year are £25,000. She incurs expenses of £8,000 and is able to claim capital allowances of £2,000.
It is not beneficial for her to claim rent-a-room relief. If she claims the relief, her taxable rental profit will be £17,500 (i.e. £25,000 - £7,500). However, if she works out her rental profit in the usual way, the taxable profit is £15,000 (i.e. £25,000 - £8,000 - £2,000).
Consequently, she does not claim the relief when filing her self-assessment tax return.
Preserving a loss
It is not possible to create a loss by using the rent-a-room scheme. Thus, if a loss arises using the usual rules to work out the taxable amount, it is not beneficial to claim rent-a-room relief.
If rental receipts are less than the rent-a-room limit, but expenses plus any capital allowances are more than the receipts, it will be necessary to complete a self-assessment return to claim the loss. The loss can be carried forward and set against any future profits that arise from lettings.
If the rental income is more than the rent-a-room threshold but deducting expenses and capital allowances would give rise to a loss, the property income pages should be completed as normal, without electing for rent-a-room relief to apply.
Example 4: Claiming a loss
Poppy runs a bed and breakfast establishment. Due to the impact of the Covid-19 pandemic, she was closed for much of the 2020/21 tax year. Her rental income was £6,500 and her expenses were £8,000.
Although her income is below the rent-a-room threshold of £7,500 and if she uses the scheme she would not need to declare it to HMRC, this would not be advantageous as she has made an actual loss of £1,500 (i.e. £6,500 - £8,000). Instead, she completes a self-assessment tax return without opting for rent-a-room relief to apply.
In doing so, she preserves the loss of £1,500, which she can carry forward to set against future profits.
Making a choice
It is not necessary to use the same method each year to work out taxable profits; instead, the taxpayer can choose each year whether to use the rent-a-room scheme depending on whether it is beneficial to do so.
An election must be made within one year of 31 January following the end of the tax year to which the election relates (so by 31 January 2023 for 2020/21). Once a choice is made, that choice remains in place until another election is made.
Practical tip
Although the rent-a-room scheme offers the opportunity to enjoy rental income of up to £7,500 a year tax-free, it will not always be beneficial. Always do the sums before claiming the relief.
