Ben Chaplin explains tax reliefs for property letting businesses, summarising the main factors to be considered
Repairs and renewals expenditure incurred in a property letting business will either be treated as a revenue expense, which is generally allowable as a deduction from property income for tax purposes, or as capital expenditure, which is not. The distinction between the two will in some cases be obvious. However, in many cases the boundary between the two is less clear.
The cost of alterations or improvements to an asset that go beyond restoring the asset to its original state is normally treated as capital expenditure and not allowable as a revenue deduction. This is an ‘all-or-nothing’ rule. It is not now possible to split the expenditure and claim a revenue deduction for what the cost of repair would have been if that course of action had been followed. This should be contrasted with, for example, the situation where a contractor is engaged to carry out various tasks, some of which are repairs and some which are capital works. In such cases, a deduction will be allowed for the repair costs to the extent that they can be separately identified.
The cost of repairing a newly acquired asset to put it in a condition where it can be used in the business is also normally treated as capital, even though the asset is merely being restored to its original state. A fairly obvious example is the acquisition of a run-down buy-to-let property, followed by expenditure on repairs that are necessary to put it in a state to attract tenants. If the price paid for the property was substantially reduced to reflect its dilapidated state then this too will be seen as an indication that the cost of subsequent repairs is capital expenditure rather than a revenue expense. These circumstances should be contrasted with the facts that led to the decision in a leading case concerning a cinema that was acquired in a state of disrepair, and the required repairs could not be made due to wartime building restrictions.
Despite its state of disrepair, the building was used in the cinema trade and when the repair work was eventually carried out the Courts decided the costs were allowable. Despite or because of this, HMRC takes the view that the cost of repairs to an asset shortly after acquisition that are necessary for its long term business use might also be capital expenditure, even if there is some short-term business use before the repairs are carried out.
This can be seen as a warning to landlords acquiring property who then enter into a short-term let in an attempt to convert necessary capital improvements into repairs for tax purposes. HMRC does, however, accept that if the work carried out is routine maintenance work, such as painting and decorating which recurs every few years, then the cost can be treated as an allowable repair. This is irrespective of whether or not there is any short-term business use in the interim.
The distinction between alteration or improvement and repair might be less clear in cases where there have been technological advances or changes in techniques or industry standards. For example, HMRC used to take the view that replacing single-glazed with double-glazed windows was an improvement. They now accept that times have changed and building standards have improved, so replacing single-glazed windows with their double-glazed equivalents can be treated as a repair. As a rule of thumb, if the technique or materials used is nothing more than the normal, modern-day equivalent to do the same job as before, then that in itself will not cause a repair to be treated as a capital improvement. In one decided case, this rule was applied to a building that was more than 400 years old! On the other hand, if the work carried out significantly changes the character of the asset, the cost may be capital. For example, the cost of replacing a wooden garden fence with metal railings would probably be capital expenditure. The fence and the railings both serve the same purpose but, even if it can be argued there is no improvement, the nature or character of the asset has changed.
Let us assume the expenditure in question has not been classified as capital by virtue of any of the tests looked at so far. Case law now goes on to tell us that a repair is the restoration by renewal or replacement of subsidiary parts of an asset, whereas the cost of replacing the whole asset is normally capital expenditure.
Identify the asset
The next stage is therefore to identify the asset concerned. To return to our windows example, a double glazing unit viewed in isolation might be looked upon as an asset, but in the context of a window repair to a let property, it is the property itself which is the asset and the window is a subsidiary part, so the cost of the window repair will be an allowable expense.
More substantial repairs can also be allowable. For example, HMRC accepts that if a fitted kitchen in a let property is ripped out and refitted along with associated re-plastering, tiling, electrical work and the like then provided the replacement items are similar to the original and the overall character of the kitchen is unchanged then the relevant costs will be an allowable repair expense. It is the whole property that is the asset and the fitted kitchen is a subsidiary part.
However, as described earlier, the cost of any additional units installed during the refurbishment will be capital expenditure, as will the whole of the refurbishment cost if the kitchen is substantially upgraded by, for example, replacing standard units and finishes with higher quality materials.
The fitted kitchen refurbishment analysis follows from the fact that most of the component parts are permanent fixtures and part of the main building rather than stand-alone assets in their own right. A fixture is something that is intended to be permanently attached to the building and to make a lasting improvement. There may be some additional components in our kitchen example other than those mentioned so far, such as fridges, freezers, hobs and ovens. These will not be fixtures and are treated as separate assets so the cost of replacing such assets will not be an allowable revenue expense.
It should be noted that if the cost of replacing the whole asset is cheaper than repairing it then this is of no relevance. Nor is the fact that using traditional materials on a like-for-like basis in an old property may be more expensive than using modern materials.
Special rules apply in certain circumstances. Electrical systems, lighting systems and heating systems all fall within the definition of ‘integral features’. Although they might be seen to be part of the fabric of the building, any replacement costs of an integral feature incurred in a period of 12 months will not be treated as allowable repair expenses if they exceed 50% of the cost of replacing the whole. In such cases capital allowances may be available.
Capital expenditure incurred on or after 6 April 2016 on certain items such as furniture, furnishings, appliances, white goods and kitchenware used in a furnished or unfurnished property letting business (but not a furnished holiday letting business) does not qualify for capital allowances. Instead, a new domestic items relief is available which, in essence, is designed to give an allowable deduction for the cost of replacement items. Owners of furnished holiday lets may still claim capital allowances on qualifying capital expenditure.
Finally, it should be remembered that if the letting activity comes within the rent-a-room relief rules then costs of repairs are not allowed as a deduction unless the property owner opts out of the rent-a-room scheme and chooses to calculate the property business profits in the normal way.
More details, including descriptions of and references to the case law decisions from which these rules are derived, can be found in the HMRC internal manuals. In particular, readers are directed to PIM2020 in the Property Income Manual and the sections beginning at BIM35430 and BIM46900 in the Business Income Manual. The manuals can be found at www.gov.uk/government/ collections/hmrc-manuals
- Ben Chaplin is MD of Croner Taxwise
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