This year has been difficult for many and landlords may not have been able to secure the full market rent for a property. Landlords may have reduced the rent charged to long-standing tenants struggling as a result of the pandemic. Alternatively, they may have allowed family or friends to occupy the property, either rent-free or for a notional rent.
Letting a property at a rent that is below the commercial rent will reduce the landlord’s income. It will also impact on the extent to which they can claim a deduction for expenses associated with the property and the let.
General rule for deduction of expenses
The general rule is that expenses can be deducted in calculating the taxable profit for the property income business to the extent that they are revenue in nature and incurred wholly and exclusively for the purposes of the business.
Where the expenditure is capital in nature, relief will depend on whether the accounts are prepared under the cash basis or accruals basis. Under the cash basis, which is the default basis for most unincorporated landlords, most capital expenditure can be deducted in working out profits, unless it is of an excluded type, such as cars or land.
Lets not at a commercial rent
If a landlord does not charge the full market rent for a property, HMRC take the view that it is unlikely that the expenses of the property are incurred wholly and exclusively for the purposes of the business. As a result, the general rule for deductibility is not met. This means that, strictly, they cannot be deducted in arriving at the taxable profit. Taking the strict position would mean that the landlord would be taxed on any rental income received without relief for any associated expenses.
However, fortunately, HMRC do not take such a harsh line. Where a property is let at below market rent, the landlord can deduct expenses incurred up to the level of the rent received. Where the expenses are more than the rent, the net result is neither a profit nor a loss. However, no relief is given for expenses in excess of the rent – these cannot be deducted to create a loss, nor can they be carried forward to be used in a later tax year. Consequently, no relief is available to the extent that the expenses exceed the rent.
A landlord may allow a friend or relative to house sit between commercial lets. If expenses are incurred in this period, they will be deductible as long as the property remains genuinely available for commercial letting and the landlord is actively seeking tenants. However, expenses incurred in a period where the property is occupied by a friend or relative rent-free and the property is not available for commercial letting are not deductible.
Timing of expenses
If there are likely to be periods where the property is occupied rent-free at below market rent, where possible the landlord should seek to incur expenses related to the property while it is being let at a commercial rent to preserve their deductibility.
Period of grace election
Where the landlord intended to let the property at full want but was unable to do so, for example, as a result of the pandemic, a period of grace election could be considered,
Partner note: ITTOIA 2005, s. 34, 272, 326A; CTA 2009, s. 268A