Furnished Holiday Lets
The taxation of residential property letting has seen some changes in recent years. The most significant is the change in tax relief on interest payments. These were once just a tax-deductible expense but are now being shifted to an adjustment to tax due instead. Whilst some landlords were unaffected by this change, others have found their rental profits moving into higher rate tax. With the tax adjustment from interest only being at basic rate, they have ended up paying more.
But there is an alternative for rental property in a popular holiday destination like Hastings. Instead of letting property for residential purposes, they can be rented as a Furnished Holiday Let (FHL) instead. The tax rules for these more closely follow those of a trade, with all the advantages (and some disadvantages) of that status.
To qualify as an FHL a property must meet three criteria
1. It must be in the UK or the European Economic Area
2. It must have enough furniture available to visitors to allow normal occupation
3. It must meet the occupancy tests (see below)
The occupancy tests require that, in each tax year
• Where there are any individual lettings of more than 31 days in succession, the total of these must not exceed 155 days.
• The property must be available for let at least 210 days
• The property must actually be let for 105 days.
With regards to the last test, there are two other potential ways of meeting this test and having a property qualify as an FHL. If you have multiple FHL properties, then this condition will be met if the properties achieve an average of 105 days let between them. It is also possible to make a period of grace election if you fail in a single year. To be able to make an election the property must have qualified in an earlier year and there must be evidence that you have made efforts to find people to let it. If both of these conditions are met, the property will still qualify as an FHL for up to two years. A property will automatically cease to be an FHL in the third year it fails to meet the last test. A period of grace election is made through the tax return.
Only commercial lettings count towards the occupancy tests. Occupation by the owner or friends and family paying nothing or reduced rates do not count. Where a let starts part way through a tax year, the first 12 months of letting should be tested.
As with ordinary trades, the activity must also be on a commercial basis. Letting the property for reduced rates out of season to help cover costs will not affect commerciality.
Advantages of an FHL
As noted at the start of the article, finance interest is ceasing to be a deductible expense for ordinary residential lettings. Such costs can be claimed in full for FHL properties.
Because the activity is treated more like a trade it is possible to claim capital allowances for FHL properties. This means you can claim the costs of furniture used in the property as well as certain fixtures and fittings.
The property is also eligible for Capital Gains Tax reliefs that are available to traders. These include Business Asset Rollover Relief, Entrepreneur’s Relief and reliefs available for gifts of business assets.
Income from FHLs also counts as relevant earnings for pension purposes. Relevant earnings determine the maximum amount you can put into a pension and get tax relief. FHLs therefore make it possible to make higher tax efficient contributions.
There is also potentially more flexibility for splitting profits where a property is jointly owned. The split of profits on rental properties is normally determined by the percentage ownership of the property in question. As an FHL follows the rules of a trade then profits can be split to reflect the work done by each partner, though HMRC will require proof of the basis of such a split.
Disadvantages of an FHL
Because it is a trade, income from FHLs are subject to VAT registration. If your income from FHLs is over the VAT threshold (currently £85,000) then you will have to become VAT-registered.
Losses from an FHL need to be recorded separately. They cannot be offset against other income, only later profits from the FHL.
Finally, because you are letting it for short periods of time, FHLs require a lot more active management. Depending on your other commitments, the extra time you have to invest may more than outweigh the available tax savings.
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