TXF6 UK
Syllabus B. Income Tax And Nic Liabilities B4. Property and investment income

B4a. Computation of property business profits

Syllabus B4a)

Compute property business profits.

How to pay income tax on property business profits?

What does property business profit consist of?

Income from land and buildings in the UK will be liable to assessment under property income.

This includes:

  • Rent  received/receivable under any lease or tenancy agreement

  • The premium received on the grant of a short lease.

Property income is assessed in the following manner:
Rent received in the tax year   x
Plus: premiums received in the tax year  x
Less: capital element of the premium received in the tax year (x)
Property business profit/loss x/(x)

From 2018/19 the default method for the calculation of property income is the cash basis - rental income received less allowable expenses paid.

This gives automatic bad debt relief as rental income is not taxed unless it is received.

Under the accruals method, whatever income is allocated to the tax year and whatever expenses are allocated to the tax year will be taxable in that tax year.

When this income is actually received in hand or when the expenditure is actually paid out does not matter.

Rental income and allowable expenses will be assessed on an accruals basis when:

  1. Property income receipts for the tax year exceed £150,000

  2. The property business is carried on by a company

  3. An election is made for the accruals basis to apply (elect by 31 January 2021 for 2018/19 tax year

For premiums received due to grant of a short lease, the entire income element of the premium will be assessed in the tax year that it is received.

This calculation will be illustrated in Topic Premiums granted for short leases.

NOTE: in your exam you should assume that the cash basis applies unless told otherwise.

Illustration:

Penny owned two properties which were let out unfurnished until both properties were sold on 31 December 2018.

The following information is available in respect of the two properties:

Property one Property two
Rent received  3,500  7,300 
Allowable revenue expenditure (4,800) (2,500) 

What is her property business profit for?

Solution

Revenue 3500 + 7300 = 10,800
Allowable cost (4,800 + 2500) = (7,300)
Property business profit 3,500

Illustration:

Anne bought a property and rented it out for the first time on 01/07/2018.

The rent of £1,000 is paid in arrears on the last day of each month. The payment for March 2019 was not received until 10 April 2019.

She paid allowable expenses of £300 in November 2018 and £500 in May 2019 for repairs that were completed in March 2019.

  • Reqiuired:

    Calculate the property income for 2018/19 using (i) the cash basis and (ii) the accruals basis.

Solution:

(i) cash basis (ii) accruals basis
Rent receivable * (1 July - 5 April) 8 x £1,000 = £8,000 (March rent was not received until after 5 April 2019). 9 x £1,000 = £9,000 (rent is accrued for the whole period from 1 July 2018 to 5 April 2019).
Allowable expenses  (£300) (£300)
(£500)
Property income assessable £7,700 £8,200

Note: On the cash basis the March 2019 rent was not received before the tax year end and so it is not taxed in 2018/19. The expense of £500 was not paid until after the tax year end and so it is excluded from the calculation. Both of these items will be dealt with in the tax year 2019/20.

Allowable expenses:

These are expenses incurred by the landlord and reduce the taxable property business profits.

To be allowable, an expense must have been incurred wholly and exclusively in connection with the business, for example:

  1. Insurance

  2. Agent’s fees

  3. Other management expenses 

    e.g. cleaning expenses

  4. Repairs

    Capital expenditure is NOT allowed, therefore repairs are allowable, however capital expenditure to improve the property are not allowed. 

    This differentiation can be made simpler by asking yourself whether the expenditure improved the income earning capacity of the property, if it did, it is likely to be capital expenditure.

    Capital allowances may be claimed for expenditure on plant and machinery used for the maintenance of the property.

  5. Interest on a loan to purchase a property (subject to a cap of  50% in 2018/19)

  6. Decorating

  7. Impairment losses
    e.g. A tenant left owing 1 month’s rent which you were unable to recover

  8. Advertising costs

  9. Cost of replacing windows, doors and boilers

  10. Motor expenses

    If a landlord uses their own vehicle to travel to and from the property they can either
    deduct the actual motoring costs or use the approved mileage allowance which we saw
    in the Topic The authorised mileage allowances.

  11. Replacement furniture allowance (this replaces the old wear and tear allowance and is available for all properties (except furnished holiday lets) whether fully or part furnished)

    Individuals and companies deduct the actual cost of replacing furniture and furnishings when calculating the property income from renting out a residential property.

    Furnishings include items such as beds, televisions, fridges and freezers, carpets and floor coverings, curtains, and crockery and cutlery.

    There is no relief for the initial cost of furniture and furnishings, there is only relief when assets are replaced.

    The amount of relief is reduced by any proceeds from selling the old asset which has been replaced (Replacement cost - sale proceeds = replacement furniture relief).

    Also, relief is not given for any cost which represents an improvement, for example, if a washing machine is replaced with a washer-dryer, only the cost of an equivalent washing machine qualifies for relief.

    Example, during April 2018, Fred furnished a residential property with a cooker costing £440, a washing machine costing £330, and floor coverings costing £2,200.

    The cooker was sold during December 2018 for £110, and replaced with a similar model costing £460.

    The washing machine was scrapped, with nil proceeds, during March 2019.

    It was replaced by a washer-dryer costing £670, although the cost of a similar washing machine would have been £360.

    What would the replacement furniture allowance be?

    Replacement furniture relief:
    Cooker (£460 – £110) = (£350)
    Washing machine    =  (£360)

    Note:
    No relief is available for the initial cost of the cooker, washing machine and floor coverings.

    Relief for the replacement cooker is reduced by the proceeds of £110 from the sale of the original cooker.

    No relief is given for that part of the cost of the washer-dryer which represents an improvement over the original washing machine.

Illustration - Impairment losses under the accruals basis

Howard had an unfurnished property and charged rent of £800 per month payable at the end of each month.

The property was let from 06/04/2018 - 31/12/2018 when the tenant left owing 1 month’s rent which Howard was unable to recover. Allowable expenses paid in the period amounted to £500.

  • What is Howard’s property income assessable for 2018/19 using the accruals basis?

Solution:

Rent receivable 9 months * £800 =  £7,200
Impairment losses 1 month * £800 = (£800)
Allowable expenses =  (£500)
Property income assessable =  £5,900
Note: impairment losses do not exist under the cash basis as property income is based on rental income actually received.

Pre-trading expenditure

Relief is available for revenue expenditure incurred before letting commenced.

  • This means that it must be incurred within 7 years of renting

  • It will be treated as though it is incurred on day 1 of renting

Illustration:

Hailey owned a furnished flat that she acquired on 01/06/2018.

She paid mortgage interest of £700 on the loan taken out to acquire the property.

On 01/06/2018 she incurred advertising fees of £500 and paid an insurance premium of £300 for the year to 31/05/2019.
He paid decorating costs of £900 on 15/06/2018.

The flat remained empty until 01/12/2018 when it was rented for £500 payable monthly in advance.

Solution:

Rent receivable ( 1 Dec 18 - 5 April 19) 5 months * £500  = £2,000
Allowable expenses:
Decorating (£900)
Advertising (£500)
Insurance 10/12*£300 (£250)
Mortgage interest(50%*700) (£350)
Property Income    (£Nil)

Note  under the cash basis the whole of the insurance premium is accounted for in the tax year because it was paid in the tax year. Under the accruals basis, when calculating the insurance premium payable, the premium has been paid for 12 months to 31/05/2019, but we only need the premium applicable until 05/04/2019, this is why 10/12 months are taken.

Note if there was furniture that was replaced for this property, then this would also be deducted when calculating the property loss.

Notefrom 2017/18 there is a restriction on the amount of mortgage interest that can be deducted from property income. In 2018/19, only 50% of the interest can be deducted from property income. 
The remaining 50% is taken off the income tax liability at the basic rate of 20%. 
This means that any higher rate or additional rate taxpayers will not get full relief for the interest expense.

So in this illustration, Hailey deducts £350 (50% x £700) from property income and then would deduct £70 (50% x £700 x 20%) from her income tax liability.

This is explored in more detail in Topic Property Income Finance Costs.