Doug Perry of Nottingham chartered accountants Clayton & Brewill explains the costs that landlords can offset against their tax bill.
An important general rule to apply when working out if a cost can be offset against income for tax purposes is to establish if the cost is revenue or capital related. Revenue costs can be offset, capital ones can't.
So what's the difference?
Capital is defined as 'expenditure to create an asset or advantage for the long-term benefit', whereas revenue is concerned with your business's running costs.
By way of example, if you purchase a new buy to let property and are making monthly repayments, you can offset the interest element as HMRC views this as a day-to-day revenue cost.
The capital element of the repayment will however be caught within the 'long term benefit' definition and therefore not allowable as an expense.
The costs associated with buying a property or creating a lease are not allowable. However, the legal costs of evicting a troublesome tenant, pursuing rent arrears or renewing/amending an existing lease can be offset against your profits.
This is where it gets tricky. Repairs most definitely can be offset for tax purposes but the difficulty lies in defining whether or not a cost counts as a repair. We consider two key aspects in establishing what constitutes a repair.
1. Are you replacing an 'entire asset'?
The replacement of an entire asset does not qualify as a repair. From a buy to let perspective you need to look at whether the asset is a fixture of the building or a free-standing asset. For example, an immersion tank in a residential property is considered as a fixture as it will have become part of the property. Replacing this can therefore be counted as a repair. A free-standing cooker in a furnished property would meanwhile be counted as an 'entire asset' and the replacement of it would therefore NOT count as a repair and so can't be offset against profits.
2. Will the works alter the character of the asset?
Alterations or improvements that change the character of an asset – be it a kitchen or the entire building – are not counted as repairs and are not allowable. For example, if you refurbish the bathroom of one of your properties, strip out and replace the units with new ones of an equivalent quality, re-do the tiling and put in a new carpet, you can count the work as a repair and offset it against your overall tax liability. This is because the bathroom is essentially the same as before – it does the same job, albeit looking smarter.
If however you installed a shower in a bathroom that previously just had a bath, then this would count as 'altering the character' and the shower element of the work would not count as a repair and therefore not be an allowable cost.
With so many complexities and potential grey areas it's clearly essential to keep good records, especially where large costs are involved and on complex repair projects.
Clayton & Brewill acts for a number of buy to let landlords across the East Midlands. For help or advice with any aspect of your accounts or tax planning, including advice on rent accounts, capital allowances, and repair and wear & tear allowances – contact Doug Perry by email or call 0115 950 3044.