Accounting for spending on letting property before the first tenant moves in often confuses landlords – and their accountants.
Countless landlords miss out on potential tax savings because their financial advisers wrongly claim pre-letting expenses are not allowed by HM Revenue & Customs.
In fact, landlords can reclaim these expenses under certain circumstances.
Working through a case study explains the process:
A landlord buys a home as the first in a portfolio of buy to let investments, but needs to carry out some refurbishment works before moving in a tenant.
At this stage, the property is not a letting property because no tenant has moved in.
The date of first letting is all important – the date the first tenancy agreement starts. From that day, the landlord has a rental business and can put income and expenses through the accounts.
Section 57 of the Income Tax (Trading and Other Income) Act 2005 deals with expenses incurred before letting.
The law says if a landlord incurs costs for a letting business no more than seven years before the date of first letting or the expense is allowed providing the expense could not be reclaimed in another way, then they can be put through the letting business accounts as if they were incurred on the date of first letting.
The rule covers revenue expenses – these are day-to-day repairs and renewals, not improvements.
In are costs like painting and decorating, fixing the roof and replacement doors and windows.
Out are improvements – one off costs like converting the loft in to living space or adding a conservatory that add value to the property.
These are just examples, and expenses allowed under Section 57 will vary between properties and landlords.
The rule also applies to landlords letting their former home once they have moved on.
If our landlord spent £10,000 on refurbishment adding replacement windows, carpets, redecorating and tidying the garden fences etc, that money is set off against the first £10,000 of rental profits – cutting tax by up to £4,000, assuming the landlord is a 40% tax payer.
Thinking about the law, it seems perfectly reasonable that a landlord forking out money to set up a business should have a way of reclaiming that cash like any other trader.
The rule only applies to the first property in a portfolio. Pre-letting expenses for second and subsequent properties are put through the accounts as they are incurred because the landlord already has a letting business.