Robert Maas, Tax Consultant at London accountants CBW explains how to walk the line with confidence.
This article was written for and first published in Property Investor News.
Refurbish or Improve? Either way, it’s likely to be expensive. But there’s a fine line dividing the two when it comes to rental properties. Stay the right side of it and there are a number of tax reliefs available that could ease the financial pain. Here, Robert Maas, Tax Consultant at London accountants CBW explains how to walk the line with confidence.
It’s the difference between carrying out the refurbishment and its improvement that determines whether or not the taxman will deem you eligible for any of the various tax reliefs available.
The first question is whether the property has previously been let and you are refurbishing it between tenancies. If so, most of the expenditure could be deductible against rental income. This is because a lot of the cost is likely to be on repairs, which are a property business expense. The test is whether the work simply restores what was there before to its original pristine condition or whether it creates an improvement over the original.
In a way, everything is an improvement over what was there before, as you would hardly have spent the money otherwise – but that is not the test. What you need to compare the new work with is the original condition of the building. Simply making good wear and tear is a deductible expense – with one caveat: if you could not have let the building without carrying out a refurbishment at the time you first let it out, you need to look at the state of the building at that time, not the building as it was originally.
Get the builder to provide a very detailed bill and go through it item by item, asking yourself whether each one is a repair or an improvement. And it is not all or nothing. If something is partly repairs but also has an improvement element, HMRC will normally allow you to deduct the repair element even though, strictly speaking, the entire expense is disallowable. And happily, if you are not sure whether something is a repair or an improvement you are entitled to give yourself the benefit of the doubt. But bear in mind that if you take the stance that there are no improvement elements at all, you increase the risk of HMRC looking more closely at your figures.
You can also write off the whole of the cost of replacing white goods and furniture, even though this is capital expenditure. Again, HMRC will disallow any element of improvement. For example, you cannot write off the cost of fittings (including a boiler and associated radiators) unless you can categorise them as repairs. The thing to consider is whether, when you replace an item, are you repairing the house, of which the item has become a part, or you are replacing a separate item. You also need to show that the old item has ceased to be used in the property, so take it away in case a tenant finds a use for it.
If you have not let the property previously but you are refurbishing it in order to start letting it, it will be a lot harder to convince HMRC that any part is repairs. They are likely to claim that you could not have let the property if you had not done the work, so the whole cost is capital expenditure and nothing is deductible. That is not necessarily correct, but you will have a fight on your hands to convince them that you could have let the property without having carried out the works but simply chose not to do so. If you think you could have let the building, albeit at a lower rent, claim the expenditure as a deduction and have the fight with HMRC. Such arguments rarely resolve themselves on an all or nothing basis and you will probably end up with a compromise figure. You will also not be able to claim the cost of furniture and white goods because they will not be replacing goods that were previously used in your letting business. Unfortunately, this is a statutory relief, so there is no room for a compromise here.
Even if the work does not attract a deduction, you should still keep a note of the amounts involved, as they will form part of your cost of the property for capital gains tax purposes when you come to sell it. Again, this does not apply to furnishings and white goods as there is no future potential tax relief for such items – but you will be able to write off the cost of replacing them when they come to the end of their useful lives.
Finally, remember that the relief for furnishings and white goods doesn’t apply to expenditure before 6 April 2016. Nor does it apply if your letting falls within the special rules for furnished holiday lets, because you are entitled to claim capital allowances on furnishings in such lettings. These are generally more beneficial as they give tax relief for the initial cost of furnishings as well as for replacements.