The Spring Budget saw confirmation that the Finance Bill 2017 would include legislation to offer some unincorporated property businesses the option to calculate their rental profits using a simplified cash basis of accounting, rather than the Generally Accepted Accounting Principles (GAAP) currently demanded.
The announcement was originally part of HMRC’s Making Tax Digital (MTD) initiative and although these proposals were dropped from the finance bill prior to the general election, it has now been confirmed that they will take effect retrospectively from April 2017 once enacted.
Although this proposal includes the word “simplified”, do not be lulled into a false sense of security. Calculating rental profits using the cash basis may not be as simple as it seems and mistakes can be costly!
Irrespective of the accounting method used, tax relief for different types of expenditure is given in different ways and can produce varying results. In addition, determining whether an expense is allowable when calculating the taxable profit can sometimes be problematic.
Revenue expenditure includes the day to day running costs of the property business. Providing the expense is incurred wholly and exclusively for business purposes, relief is given in full as a deduction against the income in computing the rental profits. This includes the general repairs and maintenance costs of the property.
By contrast, property improvements are treated as capital expenditure and are not an allowable deduction when calculating the rental profit. These expenses are instead allowed if or when the property is sold, reducing any capital gain which may have arisen. It is therefore important to keep detailed records of expenditure to support any future claims for relief.
Although in many cases the type of expenditure incurred will be obvious, there are also many cases where it will not and guidance should be sought to avoid errors.
Interest relief restriction
An added complexity over the next three years is the interest relief restriction. The restriction is designed to restrict the relief for mortgage interest to the basic rate of tax and is being phased in from 6 April 2017. For the current year, only 75% of the mortgage interest incurred may be deducted from the rental income. The remaining 25% is then multiplied by 20% and deducted from an individual’s overall tax liability.
Replacement of domestic items relief
Many will be aware of the new relief for landlords purchasing domestic items such as furniture, furnishings, household appliances and kitchenware. Previously a wear and tear allowance equating to 10% of the rental income was available to landlords of ‘furnished’ property only. This was abolished with effect from 6 April 2016 and instead, all landlords can claim a deduction when replacing these items. Please note however this relief is only available when items are replaced, there is no deduction available for the initial purchase.
New tax allowance for property income
Also announced in the Spring Budget was an allowance of £1,000, ensuring that individuals are not required to declare this income on a tax return where the rental income value does not exceed this threshold. This measure was also put on hold prior to the general election, but it has now been confirmed that the allowance will still take effect from 6 April 2017 in its proposed form.
Although it would appear that HMRC are trying to reduce the complexity of calculating rental profits, I think we can agree that there is still much scope for the occurrence of errors. It is therefore important to take great care in arriving at the figures to be reported on the tax return and to seek assistance from your tax adviser where there is any doubt.
If you would like to take further advice on calculating rental profits then please do not hesitate to contact our experts.