Here we look at the rules for claiming tax relief on expenses incurred before you first let a property.
Landlords know that the easiest time to update a property is before it is first let. But, however necessary the work, will HMRC say it is capital expenditure that cannot be claimed against rental income?
Firstly, there is very little expenditure that is disallowable, in the strict sense. When a landlord makes a capital improvement to the property, such as adding an extension, it should still be allowable, but only when the property is sold. In other words, it is allowable as enhancement expenditure against any capital gain ultimately made on sale or other disposal (the key requirement being that the improvement is still present on disposal – you will not get capital relief for adding a conservatory if you’ve knocked it down again before the property is sold!).
However, if a landlord is investing for the long term, it may be many years before such relief is useful; this is why getting relief now as a property business expense is generally considered to be the better outcome.
Beware that, just because expenditure is necessary, it doesn’t make it automatically allowable as an immediate property business expense! Where something has to be fitted to a higher standard in order to be legal, specifically for letting (typical for houses in multiple occupation (HMOs)), the implication is that it is an improvement on the original, and therefore a capital expense that cannot be claimed immediately.
Example 1: ‘Doing up’ an apartment
Lawrence buys a modest apartment from its owner-occupiers. The kitchen and bathroom are serviceable but ‘tired’; and the property could do with re-decorating throughout.
Such expenditure is perfectly allowable against the property business:
- the property was clearly habitable before the work was done, so was capable of being let on its acquisition;
- the work would not significantly improve the underlying capital value of the property in the way that an extra bedroom might, or extending the kitchen; and
- the new bathroom and kitchen fittings are of course much better than what they replaced but, critically, they are to a similar standard as the fittings they replaced when those previous fittings were new; (i.e. the comparison is between the quality of the items when originally purchased and fitted, rather than when they were about to be replaced after, say, a decade’s use!)
Example 2: Allowable expenditure on multi-let property?
Lorraine buys a large multi-let property with communal kitchen and bathroom areas. The local authority has recently imposed a licensing regime for HMOs and the new property will need to pass various conditions before it can be let, including:
- bedrooms must have additional fire safety features, including a second fire-rated door;
- fire alarm/security electrical systems have to be installed to a higher standard/rating throughout the building; and
- Lorraine also wants to replace the kitchen and bathroom fittings, which are ‘tired’. The fittings will be to a similar standard as those currently installed.
Lorraine initially assumes that:
- the work to gain a licence must be allowable for the property business – because there otherwise wouldn’t be a property business; and
- she should be able to get tax relief on the new bathrooms and kitchen, on a ‘like for like’ basis.
As the electrical works get underway, the electrician recommends a major overhaul of the current wiring within the property, which is showing faults and is not up to current standards.
Fire safety features in bedrooms
Where replacing existing fire safety features, this would be allowable for the property business. However, additional safety measures would be an improvement to the property. The argument that these additional works are necessary to get approval for letting the building would make no difference to their tax treatment. A butcher might need premises from which to carry out his trade but, assuming he buys his next shop, that does not make the cost of the premises an allowable trading expense; it is still capital.
Fire alarm/security electrical works
The fire rating of the new installation is to a different standard than the normal domestic-quality system that was in the property on purchase. Again, despite the work being necessary to acquire HMO approval, it is not a ‘like for like’ replacement but a capital improvement.
Ordinarily, this would mean that Lorraine would have to wait until the property was sold to get tax relief on this capital expenditure. But Lorraine may be able to claim capital allowances on some of her expenditure, generally where it is not in the tenants’ living areas. Most buy-to-let landlords will not claim capital allowances on anything in their let properties because there is a general prohibition on items in dwellings, but HMOs and blocks of flats may have areas which are ‘common’ and do not comprise part of a tenant’s home. This is a complex area of the capital allowances legislation, and advice should be sought on making a claim.
Replacement bathrooms and kitchens
Just as with Lawrence in Example 1, replacing fixtures and fittings of a similar standard will generally be accepted as a repair that can be claimed against property business income. If Lorraine in Example 2 decides to have additional fixtures fitted, however, then those additional units would be a capital improvement and not immediately deductible. Typically, this could arise if Lorraine decided she wanted to add more kitchen storage space, extra cookers, or perhaps additional shower facilities in the bedrooms. Note that such improvements do not make all of the expenditure capital; where improvements are in terms of quantity rather than quality, the extra items can be dealt with as capital and the rest remain as allowable repairs, etc.
Additional electrical works
Some of the standard wiring in the building needed to be replaced as it was old. The fact that it will be replaced by ‘better’ wiring now will not necessarily make it a capital improvement, where it is merely as a result of modern practices or technology. Electrical wiring installations are generally fitted to a higher standard now than they were (say) thirty years ago, but that does not mean that they must all automatically be a capital improvement when re-wiring; so long as Lorraine’s electrician is working to a modern standard typical of a normal domestic installation, then Lorraine can argue that it is a ‘like for like’ replacement and deductible for her property business.
Just as with additional kitchen fittings, if Lorraine were to ask for additional sockets, light fittings, etc., then those extra items would usually count as capital improvements that could not be claimed (although, again, some might qualify for capital allowances). The difference between ‘ordinary’ re-wiring and the fire safety installation above is that the latter installation was to a distinctly higher standard than had previously been installed.
Landlords do not usually buy particularly high standard fittings for their properties, knowing that they may be subjected to significant wear and tear. But landlords should realise that, if they do decide to upgrade the fit and finish – perhaps to try to attract a different type of tenant – they do risk having the expenditure categorised as capital improvement, that may not be claimed immediately but only when the property is sold or otherwise disposed of.
As indicated earlier, even if an expense is not allowable immediately against the property business, it should normally be allowable as a deduction for enhancement or improvement, when the property itself is sold, etc.
The landlord should keep his or her records for any such capital expenses alongside the property purchase, so that they are not overlooked when the property is eventually disposed of.