This guidance is for individual landlords of rental property. It does not apply to companies.
This article looks at the cash basis which is now the accounting method for most landlords.
From 2017/2018 tax year onwards, the default accounting method for calculating income from property, be it commercial or residential property, is the cash basis. It replaced the accruals basis which was based on traditional accounting.
Property profits under the cash basis is simply total receipts in the tax year less total expenses paid in the tax year.
Eligibility for Cash Basis
To be eligible for the cash basis, landlords must not be incorporated businesses so this applies only to individuals or partnerships.
Landlords must have annual receipts of no more than £150,000.
Where the accounting period is less than 12 months, this limit is proportionally reduced.
Unlike sole traders and partnerships, the accounting period for individual landlords is 6 April to 5 April. If accounts are drawn up to a different date, then must use 2 accounting periods and apportion on a daily basis to 6 April – 5 April.
What receipts are included?
Receipts from tenants at the date paid whether this is to a letting agent or directly to the landlord.
Receipts on sale of assets used in the business, where the original expenditure was claimed through the cash basis e.g. a van used in the business, or computers.
- Receipts on the grants of short lease premiums (a formula is applied to split the premium into an income tax element and capital gains element)
- Receipts of disposal proceeds of rental properties. These continue to be taxed under the capital gains tax system.
Post cessation receipts are also taxed under the cash basis in the tax year of receipt.
What expenditure cannot be claimed under the cash basis?
For expenses to be allowable, they must be incurred wholly and exclusively for the purpose of renting the property. Examples of wholly and exclusively incurred expenses include insurance, letting agents, advertising, accountancy fees for the business, office expenditure.
Capital expenditure can be claimed under the cash basis with some exceptions. The following types of capital expenditure are not allowable:
- Assets not for use on a continuing basis in the business
- Assets that are not depreciating (depreciating assets have useful economic lives of less than 20 years)
- Purchase/disposal of a property business
- Assets for use in residential lets (see Replacement of Domestic Items Relief below)
- Education/training expenditure
- Lease premiums: although receipts of lease premiums are taxed when received, the expense of a lease premium is not allowable.
Replacement of Domestic Items Relief
These rules still apply under the cash basis.
This allows landlords to claim for the cost of replacing assets provided for use in residential properties. The initial outlay cannot be claimed back. The replacement of domestic items relief does not apply to furnished holiday lettings.
The claim is for the costs of replacement (including delivery costs) less proceeds on selling the old item. The replacement must be a like for like replacement of the original item i.e. no improvement.
Please see the article “Property Rental Expenses for Individual Landlords” for more detail.
Interest and other finance costs on residential properties (excluding furnished holiday lets)
Interest and other finance costs cannot be deducted as an expense from the tax year 2020-2021. Instead the landlord gets basic tax rate relief.
As an example, if interest paid during the tax year is £1000, this is not deducted from taxable profits. Instead 1000@20%=£200 is taken off the income tax liability.
The tax relief is the lower of:
- The interest and finance costs
- Property rental profits (after brought forward losses)
- Adjusted total income
Any finance costs not to receive basic rate relief, can be carried forward.
The tax reduction cannot create an income tax refund.
This treatment applies to interest on residential mortgages, interest on loans to buy furnishings, including fees and other incidental costs.
Where a loan is for a mixed property e.g. a shop with a flat above, the interest needs to be split on a just and reasonable basis.
Loans on properties exceeding market value
This is a further restriction specifically for landlords using the cash basis. Where outstanding loans on properties at the beginning of the tax year are greater than the market value of the properties when first let plus any capital improvements not deducted from profits, then relief is restricted.
Elect to use Accruals Basis
Landlords who prefer to use the traditional accounting method may elect to carry on using the accruals basis. To do this, simply tick the box on the tax return to indicate you are using the accruals basis. The election should be made within 1 year of the normal filing date for the tax year, so if the tax return is filed on time, then this condition is met.
Under the accruals basis, receipts and expenses are only accounted for in the period to which they relate to.
Multiple Property Businesses
Landlords who have multiple property businesses can choose to use the cash basis or accruals basis for each business. They do not need to use the same basis across all their businesses, this includes an overseas property business.
Landlords who have to use the accruals basis
If receipts are greater than £150,000 in a tax year, the accruals basis must be used. Where the accounting period is less than 12 months, this limit is proportionally reduced.
If a property is held jointly with a spouse or civil partner, then both owners need to use the same accounting method. They can use a different basis if they declare that they are beneficially entitled to the income in unequal shares.
Transition to Cash Basis
Most eligible landlords will have gone through the transition process to the cash basis during the 2017-2018 tax year. New landlords will by default use the cash basis.
For those who elected to carry on with the accruals basis and have now decided to change to the cash basis, the following transitional steps need to be taken:
- Ensure that income and expenses that had been accrued for in the previous tax year are not taxed again in the current tax year when they are received.
- Capital Allowances: Any written down values of assets, except cars, need be written off as an expense. Cars are the only asset that can receive capital allowances under the cash basis. This is because cars are not allowed to be deducted as an expense unlike other capital expenditure.