Sarah Laing, News Editor of TaxationWeb, outlines a useful tax relief for individuals renting accommodation in their own homes.
About the relief
The Rent-a-room scheme is an optional exemption scheme that lets people receive a certain amount of tax-free ‘gross’ income (receipts before expenses) from renting furnished accommodation in your only or main home. The current annual exemption is £4,250 a year (£2,125 if letting jointly).
Individuals can choose to take advantage of the scheme if they let furnished accommodation in their only or family home to a lodger. A lodger is someone who pays to live in the house, sometimes with meals provided, and who often shares the family rooms.
A lodger can occupy a single room or an entire floor of the house. However, the scheme does not apply if the house is converted into separate flats that are rented out. Nor does the scheme apply to let unfurnished accommodation in the individual’s home.
An individual does not need to be a home-owner to take advantage of the scheme. Of course, those who are renting will need to check whether their lease allows them to take in a lodger.
If the lodger is charged for additional services, for example, cleaning and laundry, the individual will need to add the payments they receive to the rent, to work out the total receipts. If income exceeds £4,250 a year in total, a liability to tax will arise, even if the rent is less than that.
Rent-a-room scheme and running a business
The rent-a-room scheme can apply to taxpayers running bed and breakfast businesses or guest houses, or providing catering and cleaning services as part of a letting business. In such cases, the taxpayer must complete the relevant parts of the self-employment pages of their self-assessment tax return.
Example 1 – Rent-a-room
Jo and Sinisha are single persons sharing a house as their main residence. They have for some years taken in lodgers to supplement their income. As Jo pays the greater share of the mortgage interest on the house, she and Sinisha have an agreement to share the rental income in the ratio 2:1, although expenses are shared equally.
Sinisha and Jo have elected for only the excess over the exemption amount to be taxed.
Sinisha has losses of £350 brought forward, which arose from this letting because he elected in one tax year for the exemption not to apply.
For 2005/06, the position is as follows:
Gross rents (y/e 5.4.06) 4,000 2,000
Allowable expenses 1,250 1,250
Net rents 2,750 750
Sinisha’s share of gross rents is below his one-half share of the exempt amount (£2,125) so his election to tax only the excess is deemed to be withdrawn and his share is treated as nil. Jo’s election to tax only the excess over the exemption continues to apply, so that her property income assessment will be £1,875 (£4,000 - £2,125).
For 2006/07, the position is as follows:
Gross rents (y/e 5.4.07) 5,400 2,700
Allowable expenses 2,250 2,250
Net rents 3,150 450
For both Jo and Sinisha their share of gross rents exceeds their share of the exempt amount (£2,125 each). Since their share of the expenses also exceeds their share of the exempt amount, the election to tax only the excess will be unfavourable. It is therefore assumed that Jo withdraws her election (by 31 January 2009). They are both assessed on the basis of the normal property income computation, with Sinisha’s £350 loss brought forward being set against his share.
Interpretation of rent-a-room relief and business use
The Revenue confirmed in Tax Bulletin number 12 at page 154 that rent-a-room relief is not available to exempt from tax income from the letting of part of a residence as an office or for other business purposes. The relief only covers the circumstance where payments are made for the use of living accommodation. However, the relief is not denied where a lodger living in the home is provided with a desk, or the use of a room with a desk, which he or she uses for work or study.
Advantages and disadvantages of the scheme
There are advantages and disadvantages of the scheme – it’s simply a matter of working out what is best for the individual concerned.
The principal point to bear in mind is that those using the rent-a-room scheme cannot claim any expenses relating to the letting (for example, wear and tear, insurance, repairs, heating and lighting).
To work out whether it is preferable to join the scheme or declare all of the letting income and claiming expenses via a self-assessment tax return, the following methods of calculation need to be compared:
METHOD A: paying tax on the profit they make from letting worked out in the normal way for a rental business (that is, rents received less expenses).
METHOD B: paying tax on the gross amount of their receipts (including receipts for any related services they provide) less the £4,250 (or £2,125) exemption limit.
Method A applies automatically unless the taxpayer tells their tax office within the time limit that they want method B – see below.
Once a taxpayer has elected for method B it continues to apply in the future until they tell their tax office they want method A. The taxpayer must tell their tax office within the time limit if they decide they no longer want method B to apply. They may want to do this where the taxable profit is less under method A or where expenses are more than the rents (so there is a loss).
A taxpayer may have gross receipts of £5,000 but their expenses are £6,000 so they have a loss of £1,000. Unless they opt out of method B, they will still be taxed on the excess of the gross receipts of £5,000 over the exemption limit of £4,250; that is, the taxable profit from letting in their own home will be £750.
Example 3 – where method B is better
Florence lets out a room in her own home for £100 a week. Nobody else lets a room in the house. Her gross receipts for the year are £5,200. She isn’t exempt from tax because her gross receipts exceed the exemption limit of £4,250. She has expenses of £1,000 so her profit is £4,200. The excess of her receipts over £4,250 is £950 (£5,200 less £4,250).
Using method A, she pays tax on her actual profit of £4,200.
Using method B, she pays tax on a profit of £950.
In Florence’s case, method B is better and she elects for it. The profit of £950 is included in Florence’s overall business computation if she has other rental business income from lettings outside her home. The profit of £950 will be the only rental business profit if Florence has no other letting income.
Example 4 – where method A is better
John lets out a room in his own home for a rent of £100 a week plus contributions to the heating and lighting. His total letting receipts for the year from letting the room are £5,200 rent plus £200 for light and heating = £5,400. He has expenses of £4,500 so his profit is £900. The excess of his gross receipts over £4,250 is £1,150 (£5,400 less £4,250).
John pays tax on his actual profit of £900 if he uses method A.
John pays tax on a profit of £1,150 if he uses method B.
In John’s case, method A is better. Therefore he either does not elect for method B or, if he has already done so, he tells his tax office that he no longer wants it to apply. The profit of £900 is included in John’s overall business computation if he has other rental business income from lettings outside his home. The profit of £900 will be the only rental business profit if John has no other letting income.
Changing from method A to method B and vice versa
A taxpayer can change from method A to method B (or vice versa) from year to year. But each time they want to change they must tell their tax office within the time limit.
Method B will automatically cease if the rent drops below the exemption limit of £4,250 (or £2,125). The taxpayer will then be automatically exempt from tax unless they ask within the time limit for their actual profit or loss to be taken into account. If, in the following year, their gross receipts go up and they want to use method B again, they must tell their tax office within the time limit. Otherwise they are automatically taxed on the normal rental business basis (receipts less expenses) (PIM 4050).
Alternative method of calculation
The simplified method of calculation (‘method B’ above) is contained in the Finance (No 2) Act 1992, Schedule 10, paragraph 11, and elections for it are covered in paragraph 12. The taxpayer can elect for the paragraph 11 method of calculating profits if the total of the ‘relevant sums’ exceeds the individual’s limit for the year. Any balancing charge is not counted in the total for this purpose.
Under the paragraph 11 method of computation, tax is simply charged on gross receipts less the exemption limit, and no other expenses can be claimed, no capital allowances can be given, but any balancing charge is still taxable.
In practice balancing charges in a continuing case are likely to be rare. This measure is to prevent exploitation of rent-a-room. It deals, for example, with the case where a taxpayer with a substantial boarding house business might otherwise elect for the alternative basis on a cessation of trading simply to avoid a large balancing charge.
The individual must make an election for the alternative basis of computation (method B) to apply. If there is no election then the normal method of calculating profits (method A) will apply. Once made an election is effective for that and subsequent years of assessment until the individual withdraws the election or the individual becomes exempt.
There is no special form. If the taxpayer’s return is made on the basis of method B, that may be taken as an election.
Sarah Laing CTA is author of ‘Tottel’s Income Tax Annual 2006-07’, from which the above article is extracted. The book is one of ‘Tottel’s Core Tax Annuals 2006-07’. The series is due to be launched in September 2006. Each of the new Core Tax Annuals costs just £19.95, or all six cost just £99.50! The Core Set comprises:
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