End looms for holiday home tax breaks

Helen Demuth, tax director at accountants Smith & Williamson, said: "This is the last opportunity to maximise your holiday let expenses before 6 April so as to create a loss that you can set off against your other income."

Attractive tax incentives were introduced in the 1980s to encourage individuals to invest in quality holiday property. These subsidised the purchase and running costs of a second home, as well as cutting tax bills when selling. They do this by allowing mortgage interest costs to be offset in full against other tax bills, including your main salary. Around 65,000 families currently own and run a holiday house in the UK under this tax regime, known as the Furnished Holiday Lettings rules, thereby saving themselves 30 million a year in tax.

However, the rules were found to discriminate against those with villas and apartments in European sunspots. Fair treatment to all had to be ensured, either by extending the tax breaks to all holiday properties in the European Economic Area, including Iceland, Liechtenstein and Norway, or they had to be withdrawn.

The government calculated this would cost an extra 15m to 25m. Scrapping the so-called "sideways relief" would bring an extra 20m into Treasury coffers. They decided upon the latter option. From April, losses can only be offset against future rental income, and not used to reduce your overall tax bill.

So the clock is ticking to get some help from the taxman for that new kitchen or bathroom. These should still qualify for tax relief, provided contracts are drawn up and agreed before 6 April. This equally applies to those with villas or apartments in Europe, following an interim adjustment.

Demuth said: "It means that the owner of the furnished holiday business can significantly reduce their overall tax bill in the current year by making these investments into their lettings business. It is restricted to 25,000 per annum for people who work less than ten hours per week on average in the business, but that could still give tax relief of 10,000 for a higher rate taxpayer."

Cottage owners will be hit by more changes in April 2012, which could have repercussions for holiday home landlords, many of whom could find themselves disqualified from future tax breaks completely. Under the existing Furnished Holiday Lettings scheme, your property must be let for 70 days a year, and available for letting for 140 days, with no single let longer than 31 days. From April 2012 it must actually be let for 105 days, an equivalent of 15 weeks, and available for 210 days or 30 weeks. This may be difficult to achieve in some parts of Scotland.

Leonie Kerswill, a partner at PricewaterhouseCoopers, said: "It seems unfair to UK holiday home owners, given our weather and much shorter summer season. If you have a chalet in the Alps, you can let it during the winter and still have a vibrant summer season. That simply isn't possible for many typical UK resorts."

John Whiting, a policy director at the Institute of Taxation, believes the change will trigger a swing away from the lay landlord. He said: "We will see a move away from the amateur holiday cottage owner, towards giving relief only to those providing tourist accommodation as a serious business.

"Opinion is divided over whether this is a good or bad thing. The travel industry has worried that it will depress the market and reduce the supply of quality holiday property. Others think it would be good if second-home owners were thinner on the ground and locals could afford a home again. So it is a double-edged sword."

Cash in on the windfall

Before April, all your expenses, including interest on your holiday home mortgage, the running costs, maintenance and repair, can be rolled up and offset against rental income. If the expenses are larger than the income, triggering a loss, this can be deducted from tax due on other income, such as salary or investments.

For example, if your expenses including mortgage, agent commission, cleaning, utilities, business rates and insurance come to 4,000 and your rental income is 3,000, then your loss for the year is 1,000.If you spend 10,000 before April on new furniture, or kitchen or bathroom fittings, then your loss reaches 11,000. When set against your other earnings, this is worth an extra 4,400 in the pay packet of a higher rate taxpayer.

After April, the 11,000 loss can only be used to reduce tax on future lettings.

Tax breaks on selling

When it comes to selling your second property, you currently have to pay capital gains tax at 28 per cent. However, under the Furnished Holiday Lettings rules, because you are effectively conducting a business, you can reduce the tax to 10 per cent by qualifying for entrepreneurs' relief on disposal of that business. Indeed, this is a concession available to all second-home owners if they can qualify in the run-up to sale.

If you stop meeting the holiday lettings rules, you have a three-year window to sell and still potentially benefit from entrepreneurs' relief.