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There are a number of tax reliefs available when renovating properties. In this post we’re going to look at some of the more common reliefs as laid out in the popular Property Tax Portal guide – How to Reduce Landlord Taxes.
Buying The Renovation Property
Having found the right property to renovate, the first tax liability to arise is likely to be Stamp Duty Land Tax (SDLT) where the property is in England or Northern Ireland. Land and Buildings Transaction Tax (LBTT) applies to properties in Scotland and Land Transaction Tax (LTT) applies to properties in Wales.
Relief For The Costs of Doing Up The Property
Relief for the costs of doing up the property will depend on whether the project is a property development project or an investment project, or whether a person is simply renovating their own home.
The focus here is on development and investment properties. There is no relief for revenue expenditure incurred while renovating your home. However, relief for capital expenditure on improving the property will be taken into account in computing any chargeable gain that arises when the property is sold in the event that the property has not been the main residence throughout.
Revenue V Capital Expenditure
When renovating the property, the expenses will either be revenue in nature or capital in nature. This is an important distinction as it affects how relief, if any, is given for the expense.
In deciding which camp an expense falls, the key question is whether the expense is incurred to repair or restore the property to its previous condition or whether it will enhance or improve the property.
Repairs – Relief For Revenue Expenses
As a general rule, a deduction is available when computing profits for the revenue expenses to the extent that they are incurred wholly and exclusively for the purposes of the business.
However, this is only useful where there are profits to be calculated, either because a property developer is trading or there is an on-going rental business. If a renovation project is to be used as a second home once done up and sold at some future date, there are no profits to calculate and nothing to set any revenue expenses against. The same is true where a main home is renovated. If the intention is to renovate a property prior to letting it, some relief may be available under the rules governing pre-letting expenditure.
Where repairs are undertaken by a property developer, the costs will be deductible in working out trading profits. Likewise, where there is an on-going property business, the cost of any repairs or maintenance which is undertaken can be deducted in working out the profit of the property income business.
All properties need maintaining and a landlord will need a budget for repairs and maintenance. Expenses that fall into this category will include repairs to a roof, repainting and decorating, repairing doors and windows, treating damp and rot and such like. Sometimes it will be necessary to replace an item where it cannot be repaired, for example, where windows are rotten. A replacement will count as a revenue item where it is a like-for-like replacement. However, if the replacement enhances the property beyond that resulting simply from using newer materials, it will be improvement expenditure, which is capital.
Capital Expenditure
Expenditure on acquiring the land and property itself is capital expenditure, as is anything which enhances or improves the property, such as building an extension or significantly upgrading the property, for example, replacing a wall and an old single door with bi-fold doors, upgrading the kitchen and the bathroom, etc. The question to ask is whether as a result of the expenditure the property has been significantly improved.
Where a renovation project is undertaken, there is likely to be a significant degree of improvement, and much of the expenditure is likely to be capital in nature, rather than revenue. However, it should be noted that where the degree of improvement is so small as to be incidental to a repair, the expenditure remains revenue expenditure.
This is also the case where any improvement is simply down to improvements in the materials available. This may be the case where an old building is repaired using modern materials.
Extensive Alterations To The Property
The work undertaken in a renovation project may be significant. Where alterations to a property are so significant as to amount to a reconstruction of the property, HMRC regard the expenditure as being capital in nature. Consequently, no deduction is allowed for expenses that would normally be treated as revenue expenses. The exception to this is the cost of any repairs to any part of the old building which is preserved, which are deductible in the usual way.
Repairs To A Dilapidated Property – The Capital Expenditure Trap
When buying a property, the price of the property will reflect the state that the property is in. A property that is in a dilapidated state will generally be cheaper than one that is a good state. The fact that repairs are undertaken shortly after a property has been acquired will not in itself mean that the expenditure is capital rather than revenue. However, if additional factors are present, HMRC may take the view that the expenditure on necessary repairs is capital rather than revenue. Watch points to look out for include:
- a property which when acquired was not in a fit state to use until repairs had been carried out, or which could not be let until repairs had been undertaken;
- the price paid for the property being substantially reduced because of its dilapidated state.
Where these factors are present, repairs costs may be treated as capital expenditure. However, where the price of the property simply reflects normal wear and tear (such as outdated decoration), repair costs, even if undertaken shortly after acquisition, remain revenue expenditure.
Splitting Expenditure Between Capital and Revenue
When undertaking a renovation project, work may be commissioned which incorporates both improvement work and repair work to be undertaken at the same time. Any expenditure on repairs remains allowable and can be deducted in the usual way. The split between the capital expenditure and the repairs may be apparent from the contractor’s bill or invoice. Where the contractor does not provide a breakdown, the costs can be apportioned in a just and reasonable fashion.
Relief For Capital Expenditure – Cash Basis
Where accounts are prepared using the cash basis, a deduction is permitted for capital expenditure in calculating profits, for example, of an on-going property business, unless the capital expenditure is of a type that is expressly excluded. The main exclusions are expenditure on acquiring, altering or disposing of the land or property and expenditure on the provision, alteration or disposal of an assets used in an ordinary rental property (for which relief is given under the replacement of domestic items rules). Thus, when renovating a property, enhancement and improvement expenditure cannot be deducted in calculating profits.
Relief For Capital Expenditure – Accruals Basis
Under the accruals basis, only revenue expenditure can be deducted in calculating profits. Capital allowances may be available for some items of capital expenditure, but in a letting context this is limited, although more generous rules apply to furnished holiday lettings.
Relief For Capital Expenditure – Capital Gains
Improvement or enhancement expenditure is taken into account and added to the cost of the asset when working out any gain on disposal which may be chargeable to capital gains or, where the business is operated through a company, corporation tax on chargeable gains.
Where the renovation project involves doing up a second home, relief for the capital costs will be given in working out the gain on the eventual sale.
Relief For Pre-Letting Expenditure
It may be the case that a landlord purchases a property to renovate and then let out. While the renovation work is going on, the property is not available for letting and does not form part of a property rental business. Therefore, there is no rental income and no profits to calculate, so no deduction can be given at that time.
However, all is not lost. The tax rules recognise that it may be necessary to incur expenses prior to letting so that the property can be let out. Relief is available for expenses incurred before the property is first let where the expenditure:
- is incurred within a period of seven years before the date on which the property rental business started;
- is not otherwise allowable; and
- would have been deductible if the expenses were incurred after the property rental business had commenced.
Work Undertaken While Rental Property Is Empty
A landlord may decide to undertake repairs or improvements to an existing rental property, either because these are needed or to enhance the property with a view to increasing the rental yield. The property will not be available for letting while the work is carried out. However, where there is a temporary break in letting to enable repairs or alterations to be undertaken, HMRC will normally accept that the property rental business is on-going. Consequently, expenses will be deductible in accordance with normal rules.
VAT
If you are using a contractor who is registered for VAT, you may be able to benefit from a 5% rate of VAT on goods and services supplied in connection with the renovation if the property is a dwelling that has not been lived in for two years and, once renovated, it is intended for use as a residential property. To benefit, you may need to convince your contractor that the reduced rate applies. You can refer them to VAT Notice 708 which contains the detail. However, if your contractor charges you VAT at 20%, you cannot reclaim the difference between this and the reduced rate of 5%, even if you think you are eligible.
