Landlords: are your pre-letting expenses taxed as capital or revenue?

Making changes to a property in order to either maintain or increase its marketable value is something that you, as a landlord, will likely be accustomed to. However, expecting to claim back expenses on all your work is putting the cart before the horse but it’s a trap many newer and accidental landlords fall into.

We recently ran an article on capital versus revenue for landlords that got a great response. Most questions about surrounded capital costs before a property has been let out for the first time

Here at Modina, we’ve put together a simple guide you can use to work out which of your pre-letting expenses will be taxed as capital, and which will be taxed as revenue.

Revenue or Capital – The ‘wholly and exclusively’ rule

Read through any government documentation on this subject, and we guarantee you’ll come across the phrase ‘wholly and exclusively’ at least three or four times throughout. In fact, there’s a whole section dedicated to it under the PIM2010 manual. In layman’s terms, though, it’s just well-chosen jargon that identifies an expense as allowable for tax relief under this maxim.

The government website states that unless the pre-lettings expenses are incurred ‘wholly and exclusively’ for business purposes, they cannot be offset against your income tax. The costs incurred must be applicable, in their entirety, to furthering business activity, or they will not be allowable.

The confusion for most people comes in separating costs into the correct categories.

Revenue or Capital – What counts as Revenue?

You can claim Revenue Income Tax relief on costs such as agent fees, advertising fees, and repairs – as long as they were completed pre-let and without the intention of increasing the value of the property in order to make a gain. In fact, most allowable costs that fall into this category will bring your projected profit down, which, of course, means they’re eligible to offset against your income tax bill.

Repair, according to HMRC’s PIM2020, means the ‘restoration of an asset by replacing subsidiary parts of the whole asset.’ Repair cannot facilitate improvement of an asset.

If a roof blew off in a storm and had to be replaced, the replacement would be classed as repair, and in turn the expense could be offset against income tax. However, if during the process of the repair the loft was opened up and decorated to create a new living space, the cost of rewiring, decorating, and furnishing that room would not qualify as revenue expenses.

Revenue or Capital – What counts as Capital?

You cannot claim Income Tax relief on costs that are counted as Capital, most notably: renovation work. Renovation is carried out with the intention of increasing the value of the property through improving its subsidiary assets, and in turn, increasing the amount of profit you make.

Capital Gains Tax is payable on any profit you make which exceeds the £11,300 tax-free threshold upon selling a buy-to-let property.

Revenue or Capital – Other factors to consider

There are a number of other factors to consider when placing your costs into the correct categories. They are as follows:

  • Revenue expense relief cannot be claimed on ‘repairs’ if there is evidence the property was bought for a substantially lower price due to its dilapidated state.
  • Wear and Tear allowance has been abolished as of 2016. Instead, 50% of finance costs will be available for full tax relief, and the remaining 50% available at the basic rate, for the tax year 2018/19.
  • If the asset could be used shortly after acquisition without being repaired, there will be contention regarding the eligibility of the claim to offset any repair costs against income tax.
  • Similarly, if heavy repairs expenditure is incurred immediately following a change of ownership, it would be advised to check which costs are counted as capital, and which are counted as revenue.

Revenue or Capital – an example: 

An elderly lady finds herself unable to remain in her bungalow and retires to a care-home. She is told that to maintain an income, the bungalow should be let out. However, local estate agents warn her that prior to being let, the building must be completely modernised and brought up to date. In this instance, a number of expenses will be incurred pre-let and they must each be categorised correctly.

Repairs are carried out in the bungalow to prepare it for the letting. The costs of these repairs can be counted as revenue and offset against income tax, as the lady will not benefit from them personally. They are incurred with the sole purpose of preparing the property for the market.

Some costs are a little more difficult to define, such as the replacement of kitchen units and various fittings.

HMRC’s PIM2020 states that there is ‘no improvement if trivial increases in performance or capacity arise solely from the replacement of old materials with newer but broadly equivalent materials.’ Thus, the bungalow can have its single-glazed windows replaced with double-glazing, and the old kitchen replaced with a similar, standard one, within which there was no added storage space, or further improvements made aside from replacing old units with newer equivalents.

In this scenario, the lady decides she wants to improve the bungalow by having the small glass conservatory extended. Here, the expense cannot be counted as revenue, but will be charged as capital.

Revenue or Capital – Contact us

If you need expert and impartial advice regarding your buy-to-let business and the taxes you pay, speak to one of our team on 020 7183 8241, or email us on today.