This article appeared in the Yorkshire Post on Saturday 19th May 2007.

How to Make the Most of Tax Breaks on Your Letting Property

Richard Whitelock Tax Specialist

With the holiday season nearly upon us, it seems an appropriate time to consider the tax implications of owning and letting holiday accommodation. Let property that meets certain criteria can benefit from some very favourable tax treatment, and this article seeks to highlight these tax advantages and explain when they will apply.

The basic rules are that property that is let by an individual is liable to Income Tax on any rental profits received, and to Capital Gains Tax (CGT) on any gain made on eventual sale. However, properties that qualify as furnished holiday lettings (FHLs) can benefit from far more favourable tax treatment than ordinary furnished/unfurnished lettings.

The fundamental difference, and reason for the difference in tax treatment, is that a qualifying FHL is treated as a trading asset rather than an investment asset and, as such, benefits from many of the tax reliefs that apply to trades, including the following:

Qualifying FHLs are classed as “business assets” for CGT taper relief purposes, whereas non-FHLs are not. The difference here can be significant, as the longer the property is owned the higher the rate of taper relief that will apply to reduce the taxable gain made on eventual sale. “Business assets” need only be held for a minimum of two years before the maximum taper rate of 75% applies, wiping out three-quarters of the gain from being taxed. For somebody selling a FHL who is a higher rate taxpayer, this means an effective tax rate on sale of just 10%.

For non-FHLs the rate of taper relief is less generous – you need at least three years of ownership to attract just a 5% deduction, and this increases by 5% each year up to a maximum rate of 40% after 10 years.

The various CGT reliefs that apply to businesses also apply to holiday lets, including the ability to “roll-over” any gain made on sale into the purchase of another qualifying business asset (which could be another FHL), or the ability to “hold-over” any gain if the property is gifted so that any CGT is deferred until the new owner sells it.

Rental losses made on FHLs can be offset against any other taxable income of either the tax year of loss or the year before, so tax relief on the loss is often immediate. Contrast this with non-FHLs, where losses can usually only be carried forward and offset against any rental profits made in future tax years.

Rental profits on FHLs also count towards “relevant earnings” for the purposes of allowable pension contributions limits.

In respect of Inheritance Tax (IHT), FHLs can in many cases qualify for “Business Property Relief”, which exempts the property from IHT, meaning potential tax savings of 40% of the value of the property. However, this exemption is not automatic, as the rules for this relief are quite separate to the other FHL rules in this article. The IHT relief is dependant on the degree of involvement of the owner in running the FHL “business”, so any owners who are simply passive investors (who hand over the running to an agency, for example) may not benefit from this relief.

So how, and when, does a property qualify as a furnished holiday let? Firstly, only properties that are furnished and situated in the UK can qualify. There are then a number of tests that must all be met:

• the property must be available for holiday letting to the public on a commercial basis for at least 140 days;
• the property must be actually let for at least 70 days;
• any periods of “longer-term occupation” (more than 31 consecutive days by the same person) cannot exceed 155 days during any year.

The last of these tests provides the dividing line between the usual furnished/unfurnished rental properties (where tenants would typically occupy the property on six or twelve month leases) and genuine holiday lettings (where the property is let for a week or so at a time to different tenants). It also ensures that properties let to students during term time do not qualify. These days tests are applied for each tax year that the property is let and there are special rules for the first and last twelve months of letting.

Although the above tests may appear straightforward, there can be some grey areas and certain pitfalls to watch out for. The “commerciality test” has often been an issue on which the Revenue has successfully challenged that FHL treatment should not apply.

Complications can also occur if there is any personal use of the property, which includes allowing friends or relatives to stay rent-free or below market rent, as this results in the need to apportion any expenses between the commercial and uncommercial use on a reasonable basis. If you own or are considering owning holiday accommodation to let, it is recommended that you seek professional advice.

Richard Whitelock is a Personal Tax Manager at Garbutt & Elliott Chartered Accountants (0113 273 9600) and (01904 464100).