Capital Allowances in HMOs
HMO landlords may be due a tax refund
THERE SEEMS to be a school of thought at the moment that almost any landlord with an ‘HMO’ is due a large refund from HM Revenue and Customs (‘HMRC’). It would be nice if it was true, but I must confess that I am not convinced.
What is an ‘HMO’?
The term ‘HMO’ is defined by the Housing Act 2004 and means a ‘house in multiple occupation’. It’s a very broad term which potentially covers anything from a homeowner taking in a lodger to a house with several separate flats.
Why Might There Be a Refund?
Most businesses are able to claim capital allowances: a tax deduction for the cost of qualifying expenditure on machinery, equipment, furniture, etc. Since April 2008, the capital allowances regime has been more generous when it comes to property as all ‘integral features’ are now classed as qualifying expenditure. This includes lighting, electrical systems, plumbing, heating, air-conditioning, lifts and escalators, so it can be a substantial proportion of a property’s purchase price.
It is also currently possible to claim immediate 100% tax relief for up to £100,000 per year of qualifying expenditure: this is known as the ‘annual investment allowance’.
On top of this, capital allowances can usually be set off against any source of income arising in the same tax year, or the next. All in all, a pretty powerful form of tax relief!
Sadly, tax legislation specifically prohibits landlords from claiming capital allowances on expenditure within a ‘dwelling-house’ (except qualifying furnished holiday lets).
Despite this, it is well established that the communal areas in a block of flats are not part of a ‘dwelling-house’. In fact, where any building comprises ‘self-contained’ flats, the areas outside the flats are not within a dwelling-house and appropriate capital allowances may be claimed.
Gerry buys a large house and converts it into four bedsits. She also installs a utility room in the basement.
Each of the bedsits is a ‘dwelling-house’ and the remainder of the property lying outside them is eligible for capital allowances.
Gerry can therefore claim immediate tax relief for up to £100,000 of expenditure on the ‘integral features’ outside the bedsits (lighting, plumbing, etc), as well as all of the equipment in the utility room.
So there are indeed some HMO landlords who could benefit from capital allowances claims and, if they haven’t claimed already, could get a substantial refund from HMRC.
Gerry’s position is fairly clear. For tax purposes, her property consists of four dwelling-houses plus a substantial amount of communal space: the hallways, the staircase and the utility room. All the furniture, equipment and ‘integral features’ within the communal space qualifies for capital allowances.
What is less clear, and where I tend to differ from some people currently advocating a more aggressive stance, is the position where a property is shared more extensively.
Tom rents a house to three unrelated young professionals. Each tenant has their own bedroom but they all share a bathroom, kitchen and living room.
Some people now seem to be suggesting that each tenant’s bedroom should be regarded as a dwelling-house and the remainder of the property is therefore communal space. The implication of this is that the landlord can claim capital allowances on all furniture, equipment and ‘integral features’ throughout the entire property except for the bedrooms. As you can imagine, this could amount to a substantial claim.
The first thing to bear in mind is that, even if this more aggressive interpretation is right, it will only be possible to claim a deduction for some of the ‘integral features’ where the property was purchased after 5th April 2008.
But what concerns me the most about this interpretation is that it relies on the assumption that the shared areas in an HMO of this type are not part of a dwelling-house.
This is where the waters start to get very muddy because the tax legislation does not actually define a ‘dwelling-house’ (one of many cases in the tax world where an important term is not defined). This means that we must look to see what the term’s general, everyday, or common-sense meaning is. Until a High Court judge tells us what he or she thinks it means, anyway.
HMRC interprets ‘dwelling-house’ to mean ‘a building, or part of a building, which is someone’s home’.
For Gerry’s tenants, the bedsits are their home. The hallways, staircase and utility room are not part of anyone’s home, meaning that Gerry can make a substantial capital allowances claim.
Despite having private bedrooms, Tom’s tenants are effectively sharing a single home. Hence, under HMRC’s interpretation, every part of the property is within a dwelling-house and Tom cannot claim any capital allowances.
Readers will know that I am usually one of the first to point out when HMRC are wrong but, this time, I think they are right. Not in any moral sense: it would be much fairer if all residential landlords could claim capital allowances, but in the sense that, for once, I feel that they have interpreted the law correctly (well, reasonably correctly anyway).
As an interesting aside, it is worth mentioning that, in a case like Gerry’s, where capital allowances can be claimed, she will need to apportion the cost of items like central heating, which run through all parts of the building, between the qualifying (communal) and non-qualifying (private) areas. Where the non-qualifying element amounts to no more than 25%, however, the entire cost may then be claimed.
Tom and Gerry represent the extreme ends of a spectrum. Between them, there are a great many HMO landlords where the position is less clear-cut. Where exactly does the boundary lie?
The best way to answer this question, for the moment at least, is to consider what parts of the property, if any, are not part of anyone’s home.
Somewhere near the middle of the HMO spectrum we might find a landlord with a property where there are private bedrooms which each contain an en suite toilet and shower room, a kitchenette and a small dining area, but where there is also a communal living room, bathroom and utility room.
In this case, one could argue that each bedroom has enough facilities to make it the tenant’s home. This would mean that all of the communal space was not part of a dwelling-house and all the furniture, equipment and ‘integral features’ within it would be eligible for capital allowances.
Frankly, the situation here is far from certain, even under HMRC’s own interpretation. It could be worth claiming capital allowances on all of the qualifying expenditure in the property outside the bedrooms but, whether this claim would ultimately succeed, is hard to say.
Where a property is made up of self-contained flats, a capital allowances claim on qualifying expenditure within communal areas will generally be justified.
In other cases, the grounds for a claim range from being uncertain to highly doubtful and, whilst it could sometimes be worth making a claim, there is a risk attached.
Making a Claim
If you feel you have a good enough case to go ahead and claim capital allowances on part of the furniture, equipment or integral features in an ‘HMO’ property, there are a number of ways to proceed.
You might simply claim the allowances in the next tax return which you submit. Generally, for most landlords, this will be the return for the year ended 5th April 2010. You can claim capital allowances on any qualifying items still within the property at the start of the period on 6th April 2009. However, you can only claim the 100% annual investment allowance on qualifying expenditure actually incurred during the tax year.
For earlier expenditure you will only be able to claim a ‘writing down allowance’ of 10% on ‘integral features’, or 20% on other qualifying items. This is not as bad as it sounds, as you are then able to continue claiming 10% or 20% of the unclaimed balance in each subsequent year.
In many cases, you will be better off going back at least one more year and making a claim for the year ended 5th April 2009 by submitting an amended 2009 tax return. You can do this at any time up to 31st January 2011.
Hence, where a claim is due, it will generally be possible to claim 100% relief for qualifying expenditure incurred after 5th April 2008 plus either 10% or 20% writing down allowances for earlier expenditure.
Where substantial amounts of qualifying expenditure were incurred before 6th April 2008, it may be worth making an ‘error or mistake relief’ claim. This would currently enable you to make claims as far back as 6th April 2006, but there are some potential drawbacks to this process, so professional advice is essential.
Whichever method you follow, it will generally be worth including a note to explain the grounds on which you are making your claim. In more uncertain cases, this may enable you to reduce or eliminate any penalty if your claim is ultimately overturned.
Finally, in all but the most clear-cut claims, you may wish to consider keeping any refund on deposit for at least fifteen months after submitting your claim: in case you have to pay it back!
Previously we looked at the controversy raging over the question of whether landlords can claim capital allowances on furniture, equipment and other assets within a ‘house in multiple occupation’ (‘HMO’).
Since then, HMRC has issued some revised guidance on the subject to take effect from 22nd October 2010 (see Revenue & Customs Brief 45/10 at: www.hmrc.gov.uk/briefs/income-tax/brief4510.htm).
It appears that HMRC has woken up to the fact that the earlier guidance which it issued on the subject in December 2008 (Brief 66/08) was being interpreted rather more widely than it had intended.
The main change in the guidance is that HMRC now interprets the term ‘dwelling-house’ to mean a building, or part of a building, which has ‘the facilities required for day-to-day private domestic existence’. (As explained in our October issue, capital allowances are not usually available on expenditure within a ‘dwelling-house’.)
This change of approach will make absolutely no difference to the vast majority of landlords. If we go back to the examples I used in last month’s article, Gerry (who rented out self-contained bedsits) will continue to be eligible for capital allowances on qualifying expenditure within the communal areas in her property, whereas Tom (who rented a house to three tenants who each had a private bedroom but who shared all the other facilities in the house) will not be eligible for any capital allowances on his property.
The main type of property affected by HMRC’s change of approach would appear to be ‘cluster flats’. These are typically used for student or ‘key worker’ accommodation and consist of en-suite study bedrooms ‘clustered’ in groups of around six to ten which, together with a shared kitchen/dining area and living room, comprise a ‘flat’. The flats are then usually housed in blocks, with one or two such flats on each floor.
Under the guidance issued in December 2008, HMRC accepted that each bedroom within this type of property was a separate dwelling-house, so that capital allowances could be claimed on all the qualifying expenditure within the property outside the bedrooms.
Under the new guidance in Brief 45/10, HMRC is now saying that each ‘flat’ must be regarded as a dwelling-house, leaving just the stairwell and other areas outside the ‘flats’ (e.g. lifts, boiler room, air-conditioning units, etc) eligible for capital allowances on qualifying expenditure.
For those affected by this change, HMRC will accept claims based on their earlier guidance where the qualifying expenditure took place between 29th December 2008 and 21st October 2010, or where the relevant tax return was submitted before 22nd October 2010.
HMRC guidance can be very useful: if it supports a claim, you can generally go ahead and make it without needing to worry whether it will be accepted.
Our last example in October’s article concerned a property with private bedrooms, each containing an en suite toilet and shower room, kitchenette and small dining area, but which also contained a communal living room, bathroom and utility room.
In October, I said that it could be worth claiming capital allowances on all of the qualifying expenditure in the property outside the bedrooms, but that this was a border-line case and the outcome was uncertain.
There now appears to be a fair chance that HMRC will accept such a claim where it was either submitted before 22nd October 2010, or where the expenditure was incurred between 29th December 2008 and 21st October 2010.
For those whose claim does not appear to be supported by HMRC’s guidance, however, it is important to remember that their guidance is not the law: it is merely their opinion. Only Parliament and the Courts can set the law!
The actual law relating to this issue remains unchanged and, where justified, it is still possible to make a claim on general principles, even when this is contrary to HMRC guidance.
Such cases will be rare, of course, and the outcome is far from certain but, if there is enough at stake, no one should be put off just by HMRC’s opinion when they have a valid claim.