Guidance on revenue and capital expenditure on rental income.
Generally, when calculating the rental business profits, expenses will be treated as revenue expenditure provided they are incurred wholly and exclusively for the purposes of the business and are not of a capital nature.
Capital expenditure cannot be deducted against the rental income if it forms the base cost of the property and is used in the capital gains tax computation. Capital expenditure includes the cost of land and property as well as the costs of any capital improvements.
Expenditure incurred before a property is first let out
The tax deductibility of expenditure incurred before a property is first let out depends on whether it is capital or revenue in nature. Repairs to reinstate a worn asset will usually qualify as revenue expenditure, but where a property is purchased and is not in a fit state for use in the business until the repairs have been undertaken; that expenditure is likely to be capital. Guidance on whether the cost of repairing an asset acquired in poor repair is capital or revenue can be found in the contrasting cases of The Law Shipping Co Ltd v CIR  12TC621 and Odeon Associated Theatres Ltd v Jones  48TC257.
Although both companies purchased assets in poor condition, there were key differences between the two cases. In Law Shipping, the company acquired a ship in poor condition that they would have to have repaired before they could use it. This was capital expenditure and as a result not allowable in calculating the trading profit. In Odeon, the company was able to operate the cinemas for a number of years before they carried out the repairs and also the price paid was not reduced to reflect the state of repair.
The expenditure was found to be allowable revenue expense.
Expenditure for water rates, council tax etc paid by the landlord before tenants moved in is treated as pre-letting expenditure and as a result allowable.
Wear and tear allowance
If the property is let furnished, the landlord is able to claim a wear and tear allowance. This is 10% of the ‘net’ rent and covers plant and machinery that a landlord would normally provide in a furnished accommodation, such as furniture, fridges, carpets and curtains. ‘Net’ rent is the total rent for the year, less any expenses paid by the landlord that would normally be borne by the tenant, for example utility bills.
Changes to wear and tear allowance
It is all change for the current tax year as from 1 April 2016 for corporation taxpayers and 6 April 2016 for income taxpayers the wear and tear allowance for fully furnished properties will be replaced with a relief that enables all landlords of residential dwelling houses to deduct the costs they actually incur on replacing furnishings, appliances and kitchenware in the property.
The relief given will be for the cost of a like-for-like, or nearest modern equivalent, replacement asset, plus any costs incurred in disposing of, or less any proceeds received for, the asset being replaced.
Wholly and exclusively – cost of travel to visit the property
Revenue expenses are an allowable deduction against rental income only if they are incurred wholly and exclusively for the purpose of letting. Where expenditure has a dual private and business purpose – unless the business element can be clearly distinguished – then the whole of the expenditure will be disallowed for tax purposes.
While reasonable costs for inspection visits are usually allowable, if the trip is mainly for private purposes and it is not possible to separate this private element from the business portion, then none of the cost is deductible.
Solicitors fees incurred to evict tenants or to recover rental income are treated as incurred wholly and exclusively for the purpose of the rental business and as a result are allowable. Management fees/agents’ fees will be fully tax deductible. If the landlord chooses to advertise his property privately, this cost is also allowable.
Ordinarily, the cost of redecorating would be an allowable revenue expense. However, if the work is undertaken as part of an improvement, the entire cost is treated as being capital, including the redecoration.
Finance interest payable on loans (including incidental cost of financing) used to buy land or property which is used in the rental business, or on loans to fund repairs, improvements or alterations, is deductible in computing the profits or losses of the rental business regardless of the security given for borrowed funds.
If a property is let for short periods in a tax year, or only part of it is let throughout a tax year (or both), the interest charged on a qualifying loan on that property has to be split between the rental business use and the private or non-business use. The split is done in whatever way produces a fair and reasonable business deduction, taking account of both the proportion of business use and the length of business use. The interest does not have to be split if the landlord is genuinely trying to let the property but it is empty because they have not been able to find a tenant. In this case, the interest will meet the ‘wholly and exclusively’ test.
The cost for preparing rental accounts is an allowable expense; however, the cost of completing the landlord tax return is not allowed as it is a private expense.
Changes to interest and other finance charges
From 6 April 2017, tax relief on interest paid by landlords of residential properties will be restricted gradually (by 1/4 for each tax year) so that from 6 April 2020, interest will not be an allowable expense in computing the profits of the business, but will attract tax relief at 20%. An example on how the changes will affect a basic and higher rate taxpayer can be found here.
Article from ACCA In Practice