Lee Sharpe warns that just because property repairs are necessary, they are not automatically allowable for tax purposes.
A common mistake made by landlords (and taxpayers generally) is to assume that, just because work on a property is legally required, it must be tax deductible.
Unfortunately, this is not necessarily the case: it is a quirk of tax law that an improvement, however necessary, is unlikely to be allowed for income tax purposes. However, the good news is that an element of improvement does not necessarily prevent repair costs from being allowed.
We shall look at either side of this coin, and how to make sure to get the best out of the relief available. This article is aimed at landlords/property investors of residential property, as the rules are different for property developers and for commercial properties.
The cost of improving an asset is NOT normally allowed – even if essential
As a tax adviser, I have frequently heard clients justify expenditure on alterations to buildings because they were required by law, on grounds of (for example) health and safety, fire regulations or similar. A common example might be additional work required in upper storeys to make them qualify as bedrooms, or extra fire safety requirements for short-term lettings in guest houses or similar.
It is perfectly understandable that a taxpayer might think that, if the law requires you to undertake additional costs, then they should be allowable against business income. But a cynical tax adviser might say that would be far too logical for tax!
Essentially, where money is spent on improving an asset and the benefit of that expenditure will last for years to come, then it is deemed to be an ‘enduring benefit’ to the business, and be capital in nature. From a landlord’s perspective, a simple case would be an extension: most people would agree that an extra bedroom or conservatory should enhance a property overall, and that the cost/value of the extension would be reflected in any later sale – a capital transaction.
Improvement or maintenance?
It is important to distinguish, however, between ‘improvement’, which is not allowable, and ‘maintenance’, which is. Expenditure incurred to maintain an existing asset should be allowable. This might include painting and decorating, boiler maintenance or something more substantial such as replacing wall ties or windows. Clearly, the benefit of a fresh lick of paint or a new window frame may (hopefully!) last for several years but the difference is that the asset – the property – has not been significantly enhanced beyond its original state when it was brand new. This would be the case even if it has been many years since repairs were last undertaken.
The trap for the unwary taxpayer is that by saying that work had to be undertaken in order to be permitted to let a property, they may well be confirming that the work is in fact an improvement which has a material effect on the property – it can now be let – so the expenditure is capital and must be disallowed.
Having said that, if, (for example) a health & safety inspector were merely to insist on repairs to make the property ‘as good as new’, that would not turn an allowable repair into a capital improvement.
Incidental improvements such as modern materials and techniques do NOT turn a repair into capital
Many HMRC inspectors will try to argue that a project which includes both repairs and improvements should be disallowed as an overall capital project. This is nonsense. Where the repairs can be identified separately, tax relief should be claimed. It says as much in HMRC’s Property Income manual at PIM2020.
HMRC Inspectors will also sometimes look for evidence of improvement when an old asset is replaced – typically a central heating system. However, their Business Income Manual states (at BIM46925):
“In the same way as the use of more modern materials does not necessarily mean work is an improvement, the use of new technology as part of a repair does not necessarily mean the repair becomes an improvement.”
One of the best examples of this is the tax case Conn v Robins Bros Ltd [1966] 43TC266, which is also mentioned in HMRC’s manuals, at BIM35455 and BIM35480. This case involved the substantial refurbishment of a very old building, including replacing wooden beams with steel and concrete. The property was refurbished to a modern standard, using modern techniques. Most of the work was accepted as allowable repairs. At BIM35455, it mentions that the Commissioners said:
“The character of the asset [meaning the property overall] was unchanged by the work”... more on this later.
Interestingly, HMRC seemed not to have learned the lesson over 40 years later when they took Christopher Wills v Revenue & Customs [2010] UKFTT 174 (TC) to tribunal – here again, they tried to disallow everything as a capital improvement project, but were effectively told to read their own manuals in future.
A little care needed when renovating a property immediately after purchase
A landlord will often want to renovate a newly acquired property prior to first let, when it is convenient to get the work done without disturbing a tenant. In principle, a repair is a repair. But HMRC will look to see if the purchase price was significantly reduced to reflect a building’s dilapidated condition, and whether or not it could have been let out without the additional work.
Simply put, if the taxpayer has acquired a property with a substantial reduction in the normal asking price because (for example) it has subsidence, then HMRC will argue that the costs of underpinning should be disallowed as capital – it has been substantively improved from the new owner’s perspective.
The case most often quoted in support of HMRC’s position is Law Shipping Company Ltd v IRC (1923) 12 TC 621, in which repairs to a ship on acquisition were disallowed as capital. It is worth bearing in mind, however, that this was an extreme case: the taxpayer acquired the ship at a substantial discount knowing it was basically not seaworthy and its licence would not be renewed without the very substantial further costs the taxpayer then incurred. Furthermore, HMRC’s Business Income manual at BIM46935 indicates that a price reduction merely to reflect where a property is in its routine maintenance cycle should not be taken to indicate that costs incurred on acquisition must be capital.
Practical Tip :
First and foremost, don’t fall into the trap of justifying building works on the basis of necessity: from a tax perspective, it may well indicate that the work is a tangible improvement and therefore be disallowed as capital expenditure.
At the same time, HMRC has been shown to try incorrectly to disallow repair costs as capital improvements, even in the face of its own guidance. Trivial improvements may be ignored.
Finally, I did say I would pick up the point in Conn v Robins Bros about its being fundamentally a repair because the nature of the asset was unchanged. For residential properties, ‘the asset’ is basically the property, so a new boiler is simply replacing part of an asset (PIM2020). HMRC’s manuals imply that any improvement in replacement components should be minimal – such as replacing pipes of imperial measure with those of the closest (albeit larger) metric equivalent. I have to ask, if my new boiler had double the capacity of the old one, would it ’change the character of the property’ so as to make it capital expenditure?
