Most landlords, when new to the industry, are genuinely surprised when they find out that they can’t claim every bit of expenditure back against rental profits. This article explores the differences between capital costs and revenue costs.
First, the mortgage payment. Many accidental landlords believe that the whole of the mortgage payment – capital and interest – is deductible, when in fact, this is not the case at all. Historically only the mortgage interest payment was an allowable expense but even this is being phased out, and by April 2020 landlords will no longer be able to deduct any of it from their rental income, with a “reducer” being available instead, typically equating to 20% of the mortgage interest.
Second, once you’ve bought an uninhabitable buy-to-let property and spruced it up to be, in your mind, habitable, the money you’ve spent on doing the place up will be, in many cases, non-deductible against rental profits meaning you’re faced with a higher income tax bill than you’ve budgeted for.
The second example deals with two areas of expense for landlords – revenue spending and capital spending.
What is revenue spending?
Revenue spending consists of things that you spend money on which are temporary and must be done regularly. Examples of these are the costs of repair, maintenance charges, and renewal expenses (like re-painting walls, gardening, and so on).
Revenue spending can generally be claimed against your rental profits to reduce your income tax.
What is capital spending?
Capital spending generally describes one-off purchase costs like the cost of purchasing a home, costs involved in upgrading a home, legal charges and so on.
Capital spend cannot generally be claimed against your profits, so you won’t generally see a reduction in your income tax.
Capital spending can often be claimed back when you come to sell your property. If you sell a residential property which is not your primary residence, you may have to pay 18% and/or 28% on any gain you’ve made on proceeds from sale, minus your expenses, subject to any allowances.
Is your spending either like-for-like or an upgrade?
Like-for-like replacements are generally revenue spending – upgrades are usually capital spending.
Take the example of a roof which has been badly damaged in a storm which needs re-tiling. Let’s assume that the tiles that were used were the cheapest on the market.
If you replace the tiles with similar tiles, you are making no improvement to the property as a whole from its previous state – therefore, it’s revenue spending. If, instead, you choose to renovate the roof with expensive tiles and fit a couple of skylights, you have improved the fabric of the building from its previous state – therefore, it’s capital spending.
In their property income manual, HMRC use the example of a kitchen. If you replace a kitchen with like-for-like kitchen units, it’s revenue expenditure. But what if, during the restoration of the kitchen, you add extra cupboards to the wall or increase the shelf space within the kitchen? Your spending on replacing old items and structures is revenue-spending, but the money you’ve spent on the improvements is capital spending. You will need your tax advisor to help with the split.
The major exception to this rule is around windows. Previously, if you replaced single glazed windows with double glazed windows, HMRC would consider this as a material improvement making it capital spending.
However, they now accept this is an allowable repair and state in PIM2030: “Similarly, alterations due to advancements in technology are generally treated as an allowable repair rather than an improvement, if the functionality and character of the asset is broadly the same. For example, when single glazing is replaced with double glazing.”
What about bringing a building up to a habitable state?
Not all mortgage companies will lend you money on a home which is not fit for human habitation unless you are a specialist property renovator with a proven track record.
Costs incurred in bringing a property up to a habitable standard are generally capital, and therefore claimable when selling the property, rather than against income tax, although there are some exceptions.
To finish, it is worth mentioning two famous and relevant tax cases in this area. These cases explore the issue as to whether the property was fit for the purposes of letting at the date of purchase.
The first case, back in 1923, was that of Law Shipping Co Ltd v CIR, and the second, more recently in 1971, being Odeon Associated Theatres Ltd v Jones. The shipping case concluded that costs needed to be incurred before the ship was fit for purpose, and therefore the costs were deemed to be capital.
In the Odeon cinemas case, they were able to operate without carrying out the repairs, and therefore already strictly fit for purpose. Therefore, the costs were deemed to be revenue.
Talk to us
Not only is the legislation complex in this area, it’s application by HMRC can be in many cases hard to predict. Taking advice before and after any expenditure is a wise strategy and is followed by those who dislike nasty surprises from the taxman.
For any of your property tax needs, please do not hesitate to contact RITA4Rent today on Freephone 0800 1 22 33 57 or via email by clicking here.
RITA Recommends:
- We recommend all professional landlords protect themselves and their business by gaining access to advice, information and education from a landlord association. Become a member of the Residential Landlords Association (RLA) today and join over 35,000 other landlords, just like you. Click here to become a member of the RLA today.
- Given the sheer level of tax changes in recent years, it might also be a good time to review your mortgage position. Please note we are not authorised to provide advice or arrange mortgages but we can introduce you to a firm who can. If you wish to discuss your policies or receive advice then please contact us and we will pass your details onto RLA Mortgages who are authorised and specialise within this area.
- propertychecklists.co.uk has been set up by Which? property author Kate Faulkner and offers checklists on everything from how to choose a buy to let through to securing tenants, letting them go and day-to-day management. If you have a question and want an independent answer, they will also help with that too – all free of charge!
- Finally, it can also be a great help communicating with like-minded landlords, learning about their experiences, and having a chat. You can do just that by heading over to Property Tribes today, the busiest forum for private and residential landlords in the UK.