ABOUT THE AUTHOR: Amanda Edwards TEP is an
Associate in the Private Client and Tax department at Boodle
Hatfield LLP
Mr Toad is short of money and Ratty has suggested that he rent
out a furnished room at Toad Hall. Ratty has an old friend coming
to the village who might be interested. Having a lodger might help
to deter the weasels living in the Wild Wood who had tried to take
over Toad Hall last year.
Toad’s accountant suggests Toad might take advantage of ‘rent a
room’ relief. Toad would qualify, as he is
an owner-occupier and Toad Hall is his main home. Toad will not
need to include the rental income on his self-assessment tax return
provided the gross amount received does not exceed GBP4,250 (before
deducting expenses and including amounts paid for providing meals,
goods and services, such as cleaning or laundry). The rental income
will be entirely exempt from income tax. If his gross receipts
exceed GBP4,250, he will need to consider the best way to declare
the income.
There are two ways Toad can work out the tax if rental receipts
exceed the threshold of GBP4,250. He can choose between paying
income tax on either:
(i) The profit he makes from the letting, worked out in the
usual way for a rental business (i.e. rents received minus
expenses). This is the ‘rental business’ method.
(ii) The gross amount of his receipts (including receipts for
related services he provides), minus the GBP4,250 threshold. In
this case there will be no deduction for expenses or capital
allowances. This is the ‘rent a room’ method.
If receipts exceed GBP4,250, Toad must inform HMRC if he wants
to use the rent- a-room method (ii) above, or else (i) will apply
automatically. The following examples illustrate where each option
is better.
Example 1: rent-a-room relief is
advantageous
Toad lets out one of the rooms at Toad Hall for GBP150 a week.
Total receipts for the year are GBP7,800. He is not exempt from tax
because his gross receipts exceed the rent-a-room exemption of
GBP4,250. He has expenses of GBP1,200, so his profit is GBP6,600.
His gross receipts exceed GBP4,250 by GBP3,550 (i.e. GBP7,800 minus
GBP4,250).
Using rent-a-room relief, Toad would pay tax on a profit of
GBP3,550.
Using the rental business route, Toad would pay tax on his
actual profit of GBP6,600.
In this case, rent-a-room relief is better for Toad.
Example 2: rental business taxation is
better
Toad lets out a room at Toad Hall for a rent of GBP150 a week
plus contributions for heating and light. His total letting
receipts for the year from letting the room are GBP7,800 plus
GBP200 for light and heating: GBP8,000.
Toad has expenses of GBP4,500, so his profit is GBP3,500. His
gross receipts exceed GBP4,250 by GBP3,750 (GBP8,000 minus
GBP4,250).
Using the rental business taxation route, Toad would pay tax on
his actual profit of GBP3,500.
Using rent-a-room relief, Toad would pay tax on a profit of
GBP3,750.
In this case, the rental business method is better.
Toad can change from one method to another from year to year,
but must tell HMRC by 31 January following the end of the tax year
in question. Rent-a-room relief will automatically apply if the
rent drops below the threshold of GBP4,250.
Losses cannot be claimed under the rent-a-room scheme. Losses
can be used only if Toad opts for the rental business method.
Other considerations
If Toad occupied Toad Hall as a leaseholder rather than as an
owner-occupier, he would need to check whether his lease allows him
to take in lodgers. If Toad owned Toad Hall jointly with another
person also entitled to the rental income, the exemption limit of
GBP4,250 would be reduced to GBP2,125 for each of them. He should
also check that his insurance company will continue to provide
cover. Toad currently has no mortgage, but if he had, he would need
to confirm with the lender that he can take in a lodger. Letting
more than one furnished room may amount to a trade, particularly if
material services are provided. Even if rent-a-room relief can be
claimed, using part of the home for a trade or business is likely
to restrict principal private residence (PPR) relief from capital
gains tax on a future sale. Lettings relief, however,
may be available. Where rent-a-room relief
applies and the rental does not amount to a trade or business, PPR
relief is not affected.
Correction to ‘Prepared for the worst’ in the
STEP Journal Vol21/Iss1 (February 2013, p31)
Hold-over relief from capital gains tax (under s260 of the
Taxation of Chargeable Gains Act 1992) is available on an
appointment out to a beneficiary from a settlor-interested trust
(assuming it is a chargeable event for inheritance tax purposes),
contrary to the statement in the above article. Hold-over relief is
restricted only on the transfer in, where the trust is
settlor-interested.