Meg Saksida looks at the tax position for landlords of property lettings where a market rent is not paid to occupy the property.
You love your family and your friends, and when one of them needs a roof over their head and you have an empty rental property, it is understandable if you allow them to stay either rent-free or at a reduced rent.
As that warm glow of having done something lovely for another person begins to settle, beware; as Oscar Wilde once said: “No good deed goes unpunished!” This is because even though the charitable gesture may be the right thing to do for your heart, due to the level of your tax payable potentially rising, it may not be the right thing to do for your finances.
What’s the downside?
The logic of the downside centres around why the expenses associated with the property are being incurred. Remember, for an expense to be deducted from a landlord’s income for taxation purposes, it needs to be ‘wholly and exclusively’ incurred for the letting business. The business needs to be one that is a serious undertaking which is ‘earnestly pursued’. This will indicate an activity is carried on for business purposes rather than for pleasure or enjoyment.
Allowing a friend or family member to reside in the property rent-free will not therefore be a business purpose, and the expenses deducted from an uncommercial let will subsequently not be wholly and exclusively for any business but rather, wholly and exclusively for the purpose of being a good caring relative or friend; in other words, for personal satisfaction or philanthropic purposes.
No deduction may therefore be made of the normal expenses incurred in a property that is usually or previously run as a business for a profit, as it is no longer running a commercial business. Furthermore, any loss arising cannot be claimed. This means all the expenses incurred as a result of an uncommercial letting (e.g., council tax, insurance, repairs, and mortgage interest) will go undeducted.
Discounted rent
If the landlord allows the friend or family member to inhabit the property at a reduced rent, there is a hybrid of rules. The undertaking is now classified as a business due to the rental income, which allows expenses to be offset for taxation purposes. But they can only be deducted up to the level of the rental income, meaning no loss can be made, nor can any loss be carried forward to reduce profits in a future year.
Similarly, a rental business may still be in the process of being carried out when the friend or relative is temporarily living in the residence. For example, a holiday home let on an online short-term letting service but fortuitously falling empty for a few weeks when a friend has annual leave, is used by the friend at a nil or a reduced price. The business is still running but an apportionment of the annual costs of the property will need to be made to establish those expenses associated with the uncommercial let compared with those associated with the commercial let. If the pro-rated costs exceed the rental income for the commercial element, this loss may be recognised and carried forward. If the property is let free of charge, no costs can be offset during the uncommercial letting period. If the property is let at a reduced price, the pro-rated costs can be offset, but if they exceed the rental income received, no loss can be created.
Deducting costs
Apportionment is not always made on a ‘time-spent’ basis. Sometimes it may be fairer to apportion them on a different basis. Where a very expensive repair or replacement of an item happens in the tax year where the property has been let uncommercially, it may not be just to allocate a time-spent apportionment of that expense to the uncommercial let period. For example, an apartment, usually let out as a B&B, was let to a friend for a month in-between lets, in a year where the kitchen was replaced. One-twelfth of the costs of the kitchen, which had obviously dilapidated over several years, would not be an appropriate apportionment. Such “heavy expenses”, as described by HMRC, “may be fairer to attribute more than a proportionate share to the cost of the rental business”. Note that the replacement of domestic items relief will not be available on an uncommercial letting, as the conditions include a requirement for the item to be used wholly and exclusively in the trade.
If the landlord has more than one property, and only one of them is an uncommercial let, there may be some general expenses which need to be apportioned. For example, a landlord with six let properties in one apartment block, one of which is let to his nephew rent free, may arrange to fit new bathrooms into all six. The deductibility of the cost of the furniture for the new bathrooms would be simple, with the let properties enjoying full deductibility and the cost of the uncommercial bathroom not being deductible, but the overheads may need to be split. For example, the delivery costs of the furniture, the cost of the plastering and painting, and the foreman’s time would all need to be allocated to each bathroom, and the uncommercial let bathroom’s share, deducted.
House-sitting
In some areas and at some times during the year, a landlord may request a friend or family to stay in the property to ensure it is not empty for security or other reasons. This type of ‘house-sitting’ does not count as an uncommercial letting as long as the property is genuinely available for commercial letting and the only reason no one is in the residence at that time is because the landlord is between tenants. The landlord must also be actively seeking to let the property through advertisements or agents. In these situations, expenditure may be incurred as if the property were simply sitting empty, and losses are able to be made and carried forward.
The reason for this is the difference in the motivation for the friend or family member living in the property. If the friend or family wishes to stay in the property, the landlord is doing them a favour by allowing them, and any expenditure incurred is therefore a result of the landlord’s personal kindness allowing the friend or family member to stay rent-free or at a lower rent. However, if the landlord wishes the friend or family to stay at the property, the friend or family is doing a service to the landlord and the service is incurred for the purpose of the business. It could be compared to paying for a house sitter or security guard if no family members or friends were available, which would be a justifiable deductible expense if a break-in was feared and wholly and exclusively for the business.
Capital allowances
Plant and machinery purchased for uncommercial lettings will need to go into a separate pool. Depending on the extent of non-business use, they will be reduced on a ‘just and reasonable’ basis.
Practical tip
If a landlord wished to allow friends and family to occupy a let property and does not wish for this good deed to be penalised, they should make sure that there is a good business reason for it. Is the dwelling in a bad area where there is a risk of theft or vandalism? Has the property been left in a bad state by previous tenants, meaning inhabitation by friends or family can prevent pests attracted by rubbish left behind? Ensure, too, that during their occupation, the property is available for letting and advertised as such.
