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Tax Essentials: Direct Taxes 2005-06 by Mark McLaughlin ATII TEP

Mark McLaughlin CTA (Fellow) ATT TEP and Sarah Laing CTA, provide a brief outline the tax treatment of UK land and property for individuals.All income from UK land and buildings is treated as arising from a single property business (or ‘Schedule A business’ before 6 April 2005) and is taxed as investment income, except where the business activities amount to a trade (eg a hotel business). This means that all receipts and expenses derived from all UK properties held by an individual are aggregated to produce a profit or loss for the business.

Example

Graham owns a house in Cyprus, which he only managed to let for 7 weeks in 2004/05. As a result he made a net loss from that property of £1,500. He also owns a flat in London which was let for the whole year and generated a net profit of £4,000 for 2004/05.

The loss from the Cyprus property of £1,500 cannot be set against the profit of £4,000 from the London flat as it arose on an overseas property and must be kept separate. The Cyprus loss can be carried forward to set against future letting profits from overseas properties.

Property business profits

Rental business profits are computed on the same basis as the profits of a trade, using generally accepted accounting practice. Expenses are generally allowable if they are incurred wholly and exclusively for business purposes, and are revenue as opposed to capital in nature. Capital allowances are deducted as a business expense.

Losses

The losses of a property business are computed in the same way as profits. Rental business losses are generally carried forward and set off against future property business profits. Alternatively, it may be possible to set off losses against total income of the same year (or the next following year), to the extent that they relate to capital allowances or allowable agricultural expenses.

Allowances for capital expenditure

Expenditure on land and the structure of buildings is treated as part of the cost of the asset for capital gains tax purposes. Where appropriate, agricultural or industrial buildings allowances can be claimed (see Chapter 12, Self-employment). In addition, for expenditure incurred on or after 11 May 2001, 100% capital allowances can be claimed for the cost of renovating or converting certain space above commercial properties into flats for short-term letting. If the 100% allowance is not claimed in full, a writing-down allowance of 25% a year (on cost) can be claimed until the expenditure is fully relieved. Stringent conditions apply, however, for expenditure to qualify.

Plant and machinery allowances are available for expenditure on certain types of equipment used in the rental business. Such expenditure is ‘pooled’ together for capital allowances purposes.

Capital allowances are not available for expenditure on furniture and furnishings for use in dwelling houses. However, a deduction for wear and tear may be claimed, equal to 10% of the ‘net rents’ from furnished lettings (ie after deducting payments that would normally be borne by the tenant, such as water rates). In addition, a deduction may be claimed for replacing fixtures that are an integral part of a building (eg central heating systems), but excluding additional expenditure on ‘improved’ versions of those items. However, replacing single glazed windows with double glazed units is treated as allowable repairs and not disallowable improvements.
As an alternative to the 10% wear and tear allowance, a ‘renewals basis’ may be claimed. No relief is allowed for the original cost of an asset, but a deduction is given for the cost of replacing that asset.

HM Revenue & Customs Extra-Statutory Concession B47

This concession sets out the conditions under which a deduction for 10% of the net rents may be made for wear and tear on the furniture and furnishings in a let property. It also explains when the cost of renewing certain items which are fixed to the building such as a bathroom suit may be deducted, even though the 10% wear and tear allowance has been claimed.

The tax charge

Unlike normal trading income, property business profits (or Schedule A business profits, before 6 April 2005) are taxable as investment income. This distinction is important because there are more reliefs available for trading income than non-trading income.

The profits of a property business are normally charged to tax based on the tax year itself (different rules apply to trading Partnerships (see Non-trading income)). Income from both furnished and unfurnished lettings is included as profits of the property business. Furnished holiday lettings income is also taxed as a property business, although it is effectively treated as trading income for most tax purposes.

Income tax on property business profits is usually collected as part of the self-assessment system of payments on account and balancing payments. Special rules apply to the UK rental income of non-resident landlords.

Further information

HM Revenue & Customs Help Sheets for the land and property tax return pages:

SA 105 (Notes) Notes on Land and Property
IR 250 Capital allowances and balancing charges in a rental business
IR 251 Agricultural land and ‘land managed as one estate’

HM Revenue & Customs booklets concerning land and property:

IR 150 Taxation of rents. A guide to property income
IR 87 Letting and your home

June 2005

Mark McLaughlin CTA (Fellow) ATT TEP is a tax consultant and Editor of TaxationWeb. Sarah Laing CTA of CPE Consulting is an author.

The above article is adapted from ‘Tax Essentials – Direct Taxes 2005-06’ published by Tottel Publishing. To order Tax Essentials: Direct Taxes 2005-06, click here