Calculating taxable property income (gross rents less allowable deductions) is not as straightforward as it may at first appear. A common mistake made is assuming that everything spent in connection with the rental property is an allowable expense. However, the correct treatment is far less straightforward.
We will start with the less tricky areas. Here are typical expenses to see in residential property accounts:
This is not an exhaustive list, just a simple summary of typical expenses. The two areas that can cause the most trouble are Replacements of domestic items and Repairs.
Repairs
Things can become more tricky when it comes to determining the difference between repairs and improvements. Repairs will be an allowance expense when calculating the taxable income. Improvements will typically add value to the property and in most cases will be treated as a capital expense. Provided the improvement is still in existence when the property is sold the expense would reduce the capital gain.
Consider the following example. A boiler breaks down and an engineer is called out to service and repair it. This would be a straightforward expense in calculating taxable income. What if the boiler couldn't be repaired and needed replacing, would this be deductible from income or a capital expense? Before you say yes or no let's consider a little more as this is where is can become even tricker. If the boiler is replace to a similar specification (no substantial upgrade is made) then it will be considered as a deductible expense. On the other hand if the landlord took the opportunity to install a significantly upgraded boiler or even change the system then an improvement has been made to the property and the expense would become capital and taken into account if and when the property is sold.
Another consideration is for newly acquired properties. If they are purchased in a run down state will the costs of refurbishing it be a deductible expense for future rental income? Again it won’t be a simple yes or no. The answer will be guided by the condition the property was in. A property may be dated and a bit tatty but in a suitable condition for habitation and everyday living. On the other hand if the property was in such a poor condition that would prevent it being realistically used as a home the associated costs would be capital in nature and not deductible against rental income. To support any decisions to claim repair and refurbishment costs incurred before letting income is received it would be sensible to take detailed pictures of the entire property to demonstrate it's actual condition.
An additional consideration would be works required to bring a property up to minimum EPC ratings prior to letting. Careful consideration should be given to identify if these expenses would come under repairs or fall into improvements.
Replacements of domestic items
For those involved with residential letting income for many years you may well remember the wear and tear allowance. This was available for properties let fully furnished. An allowance to cover these costs was 10% of gross rents (minus a few costs in certain situations). This allowance was scrapped some years ago. Now a deduction can be claimed for replacing domestic items (furniture, white goods and ovens etc.). The key word is replacement. The initial cost of such items is not a deductible expense. So when a property is first acquired or it is first furnished the costs associated with domestic items should not be included as an expense. Future replacements can qualify however care should still be taken. The replacement should be to a similar standard. If the new item is a substantial upgrade the allowable cost is limited to what it would have cost to replace the item to a similar standard.
We hope you have found this article helpful. A key takeaway point should be don't rush to make a decision on whether an item can be claimed as an expense. Take the time to ask a few questions, consider the context and once you have made the decision keep a record justifying the approach. If you would like to see how we can assist you do this and give piece of mind please give us a call or send us a message.
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