A unique feature of a furnished holiday letting (FHL) compared to other types of residential property businesses is the ability to claim or lose capital allowances when the residential property is sold. A failure to properly understand the rules can be a costly mistake for Buyers and Sellers alike.
What are Capital Allowances?
If you rent other residential property you should be familiar with the Rent-a-Room Scheme and Replacement of Domestic Items Relief (which replaced wear and tear allowances in April 2016). These are not available for FHLs which have different rental income computations for tax purposes.
Instead of the above, the tax system rewards FHL property owners in the same way as other commercial property owners, by allowing them to deduct certain types of capital expenditure and set it off against income or corporation tax arising from the rents generated. The same expenditure may also be used to offset any capital gain on disposal (restrictions apply when a loss is created). The rules around deductions of repairs and maintenance are the same.
Given that a new luxury FHL villa may have up to 45% of its cost eligible for capital allowances the tax benefits can be significant. For example, a high earning individual could legitimately generate an income tax cash saving of £18,000+ for every £100,000 incurred.
Of course, the actual level of allowances can vary considerably between property types but the types of allowable expenditure you should look out for include: -
Heating, electrical and air-conditioning systems
Kitchen worktops, cupboards, shelves and appliances
Baths, sinks, toilets, showers and vanity units
TV’s, Satellite Dishes, Telecoms and Data Systems
Swimming pools, hot tubs and jacuzzi
Loose fittings, furniture and equipment
Generally, although not always, the older the property and lower the specification, the lower the likely level of capital allowances and more details about capital allowances in FHLs can be found here.
Losing, Retaining or Passing on the Benefit
Whenever a business claims capital allowances and disposes of the qualifying asset they are required to bring a disposal value into account reflective of the sale proceeds involved. If you sell the qualifying asset for a profit you will likely have to pay back all the allowances previously claimed. This is designed to ensure you are only compensated for the real net cost to you.
In these circumstances, the capital allowances claimed may only offer a timing advantage and are sometimes referred to as an interest free loan from HM Revenue & Customs (HMRC) as a result. However, an unusual feature of the capital allowances legislation is that when the qualifying asset becomes a fixture you can agree an alternate valuation with a Buyer to suit the parties commercial needs.
Contract allocations in the sale agreements are not valid for this purpose, only an election (which must be submitted to HMRC with your return) will secure the desired position.
You can never elect for more than the original qualifying cost or sale proceeds, but you can elect for as little as £2 which means your capital allowance claim can become a permanent tax saving.
The trade-off is that any Buyer will inherit this capital allowances election value until new qualifying expenditure is incurred. If you are selling to someone who is not interested in operating the property as a FHL, a low elected disposal value may be of little consequence and readily acceptable.
If you have claimed all your available allowances (i.e. there is no unused balance left in the capital allowances pools) any disposal value will be added to your taxable profits for the period involved. This is called a balancing charge and therefore, most Sellers will want to keep this to a minimum.
Cessation of Property as a FHL
If you cease to meet the FHL operating conditions (e.g. because you decide to live in the property yourself) you will be required to bring a disposal value into account that reflects the ‘market value’ of the qualifying items involved instead.
Arriving at the correct value is a specialist area of tax valuation. Indeed, even HM Revenue & Customs (HMRC) requires its Inspectors to refer such calculations to the Valuation Office Agency (VOA) for approval. An election in this scenario is not allowed and specialist advice should always be sought to mitigate such effects.
HMRC Only Wants to Pay Out Once
If you buy a second-hand property you will need to understand the uses not just by the current Seller but potentially past owners before making any claim. This is because HMRC does not want to pay out more than once on the same qualifying expenditure and the capital allowances legislation contains numerous restrictions to limit claims (in some cases to nil) to achieve this aim.
If your immediate Seller operated the property as a FHL, or bed and breakfast, your claim is likely to be limited to the election value set out above. If you are unable to obtain a valid election from the Seller you will be restricted to nil. If you have details of the Seller’s original claim and dispute their proposed election value you can refer the matter to Tribunal for independent assessment.
If the Seller was entitled to claim capital allowances and chose for whatever reason not to, your claim will be restricted to nil. If the Seller owned and operated its business before 2008 you might still be entitled to a small claim uplift (2% to 3%) for certain ‘integral features’.
If the Seller was not entitled to claim (e.g. because it was their main residence) you will only be entitled to claim allowances if you can prove that they owned the property since 24th July 1996. If they acquired the property after this date you will still need to ascertain the details on the past owners use and claim position. The onus is on the Buyer to prove this tax history and HMRC are known to reject claims in their entirety without the proper research.
Because developers are not entitled to claim capital allowances you should be entitled to claim capital allowances on a ‘just and reasonable’ apportionment basis of the purchase price which again will require a specialist valuation.
At Furasta Consulting we combine tax, surveying and construction expertise to help FHL business owners and their advisors make the most of PMAs and make claims in confidence.
If you would like further details, please do not hesitate to contact us.