When it comes to tax, all types of rental income are not equal. The way in which rental income is taxed depends on the nature of the letting. This article provides an overview of the rules applying to different types of let.
 
Residential property
 
As a general rule, income from all land and property in the UK is treated as forming part of a single rental ‘business’. This approach applies to all properties owned by the same person in the same legal capacity.
 
This means that, regardless of the number of properties owned, a person is taxed on the net profits from all of their let property. This is calculated by adding together all of the rental income and then deducting all allowable expenses – income and expenses or profits and losses. The advantage of this approach is that a loss on one property is offset automatically against a profit on another. The resulting net profit is then taxed as property income. If a loss remains, it can be carried forward and set against future property income from the same rental business. It cannot be set against other, non-rental, income. It is worth noting that neither the initial cost of furniture and furnishings nor capital allowances are deductible from residential letting income – however, alternative reliefs are available.
 
These general rules do not apply to all types of rental income. Separate rules apply to furnished holiday lettings, accommodation let in the taxpayer’s home and overseas lets.
 
Furnished holiday lettings
 
Special rules apply to furnished holiday lettings (FHLs), which allow them to be treated as a trade and, in doing so, afford them a more beneficial tax treatment. Following previous changes to the rules on 6 April 2011, further changes are planned from 2012/13. To qualify as an FHL, tests regarding availability and occupancy must be met as follows:

·         The property must be available for commercial letting as holiday accommodation for at least 140 days a year (210 days from 2012/13 onwards);
 
·         The accommodation must actually be let on a commercial basis as holiday accommodation for at least 70 days (105 days from 2012/13); and
 
·         The accommodation must not be let for periods of longer term occupation (over 31 days) for more than 155 days in the tax year.
 
Advantages of the FHL rules include an entitlement to capital allowances and the availability of capital gains tax reliefs for traders, such as business asset rollover relief and entrepreneurs’ relief. Following a change in April 2011, losses must be carried forward and set against profits of the same UK FHL business.
 
Rent-a-room scheme
 
The rent-a-room scheme allows rental income from letting furnished accommodation in your only or main home (either owned or rented) to be received tax-free up to a limit of £4,250 a year. Where the accommodation is let by two or more people, the limit is £2,125 per person. The scheme does not apply if your home is converted into separate rented flats.
 
If rental income exceeds the limit the taxpayer has a choice as to how it is treated. Either the excess over £4,250 (or £2,125) is taxed, or the profit is worked out under the single property rental business rules outlined above (and aggregated with other rental income as appropriate).
 
Overseas property income
 
UK and overseas property income must be kept separate but similar rules apply to calculating FHL income for properties in the European Economic Area. Otherwise, overseas rental property is taxed in a similar way to UK rental income, with all overseas properties treated as forming part of an overseas property business.
 
For further information and advice on tax and property, please contact us.