Top Ten Tips: Cash in on your spare room

MORE people are letting out their spare rooms or homes than ever before, taking advantage of high demand for rental property to boost their incomes.

And the income generated by letting out a room or home can be significant, not least because of the various tax perks that are available if you do. Alex Docherty, tax director at chartered accountants and business advisers Johnston Carmichael, offers his top tips on generating income from residential property and understanding the tax implications.

Claim your ‘rent a room’ tax allowance

This tax relief applies to owners and tenants who receive income from letting a spare furnished room in their only or main home. As long as the income from this does not exceed £4,250 a year it is not subject to income tax.

Get more from the holiday home

Owners of holiday homes within the UK or EC can benefit from a number of income and capital gains tax (CGT) advantages. If your holiday property meets the criteria – including being available for public let at least 210 days a year and qualifying as a furnished holiday let (FHL) – your letting income will be classified as “earnings” for pension purposes.

Any capital gain made on the sale of an FHL will only be subject to the 10 per cent CGT rate (provided it was a commercially run holiday let for at least 12 months). This is a significant reduction compared with the normal 28 per cent CGT rate applying to the growth in value of let properties.

Cut your IHT liabilities

An FHL being operated as a commercial enterprise can potentially attract 100 per cent relief from inheritance tax (IHT). As a recent tax case highlighted, by making an FHL more akin to a hotel by offering enhanced services such as restaurant bookings, car hire and meal provision an owner can demonstrate that it is an active business, rather than just a business of holding an investment asset.

In IHT terms this is a valuable tax relief because upon the death of the property’s owner and it being passed onto a beneficiary, it will not be subject to the usual 40 per cent tax as it is classified as “business property”.

Wear and tear clawback

For residential properties which do not meet the FHL conditions, such as those used for long lettings, income from these properties is taxable as property income and does not receive such advantageous tax reliefs. However, relief is available in areas including wear and tear of furniture when renewing it or through a 10 per cent allowance.

Don’t stick around

Occupying your let property as your main residence for a temporary period could reduce any capital gains tax payable on a disposal of the house and reduce the amount of tax due at 28 per cent. Deciding to occupy a let property as your main residence can therefore be a way of reducing your overall exposure to CGT on the property.

Keep a record

It is vital to keep details of all income and expenditure incurred on rental properties for at least six years. The details of the original costs incurred in the acquisition of the property such as estate agent and legal fees are also allowable expenses in computing any gain arising on the disposal of your rental property.

Deduct letting-related costs

There are various allowable expenses which can be deducted and offset against any rental income. These include letting and management fees, legal and accountancy fees, repairs and maintenance and other relevant administration fees. As noted above, keep a record of these and ensure they are offset against rental income.

Create a trust

Putting a property into a trust is a useful option for those looking to pass assets on to the next generation. Structured correctly, the value of the property transferred into trust will not incur inheritance tax charges up to certain thresholds (£325,000). If a husband and wife make a joint gift into trust then property of up to £650,000 could be settled.

Review ownership

Married couples should ensure that any rental properties are held in the most tax-efficient manner. For example, if a property is held solely in the name of the top earner, gifting it to the spouse could reduce the income tax payable on the rental income and assist in equalising the estates for inheritance tax purposes.

Account for overseas lettings

Any income received from letting overseas properties is likely to be liable to UK income tax. In addition, you may have tax and reporting requirements in the overseas country where the property is situated. However, a deduction should be available against your UK tax for this, subject to agreement between that nation and the UK’s tax authorities.