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Sarah Bradford looks at the tax implications of taking lodgers into your home.

Introduction

Taking in a lodger has distinct advantages financially, but can pose a problem for Capital Gains Tax purposes!

Record numbers of cash-conscious homeowners looking for help to pay their bills may find the lure of a tax-free income offered by the Rent-a-Room Scheme attractive – but need to stop to think about the Capital Gains Tax (CGT) consequences of taking in lodgers.

One website, spareroom.co.uk, has reported almost 16,000 homeowners advertising for a lodger during the first quarter of 2010, which is a third more than the previous quarter and the highest level since the website opened for business in 2004.

The number of homeowners looking to become live-in landlords was also 10% higher than the same period of 2009 and 68% up on the first quarter of 2008.

Lodgers pay an average of £381 a month, rising to £598 in London.

How Does the Rent a Room Scheme Work?

The Rent–a-Room Scheme applies to Income Tax and allows homeowners to earn £4,250 a year without paying any Income Tax from letting to a lodger.

Tax-free income apart, homeowners must also understand how taking in lodgers can affect CGT if they sell their home because the rules are specific about CGT reliefs a homeowner can claim, if they share their home with others.

Most homeowners are aware that Lettings Relief applies to the period between owners giving up their property as a home and the last 36 months of ownership when an owner rents out all or part of a property that was once their main home.

But Lettings Relief can also apply to property owners who stay in their home and take in lodgers.

Key Factor

The key factor is that CGT relief is limited to the part of a property that the owners have lived in as their main residence except –

• If the owner has shared the home with a single lodger at any specific time, or
• If the owner has shared with live-in staff 

This rule must be applied correctly to claim the maximum available CGT relief because –

• Homeowners can have one lodger at any one time to claim Private Residence Relief and Lettings Relief on all their property. This effectively makes letting under the Rent-a-Room scheme tax exempt for CGT as well as Income Tax. So, an owner can have five lodgers over five years, as long as only one lodger lives in the home at any particular time, and still claim reliefs to cut the amount of CGT they pay on selling their former home.
• If the owner took in two or more lodgers at any one time, the taxman could argue that the activity switches from taking in a lodger to running a lodging house.

With that switch comes the dreaded business tax treatment of rooms used by lodgers – and CGT rules exclude any part of the premises used exclusively for a trade from Private Residence Relief and Lettings Relief.

Practical Tip

The message for homeowners is clear – tread a careful path between tax-free rent-a-room income and turning your home into a lodging business.