Landlords could have been said to be the ‘forgotten business’ of the Covid pandemic – granted, they were able to take a three month ‘holiday’ from mortgage payments but they were not given any direct help from the government (apart from business rate holidays and grants for Furnished Holiday Lets).
Despite assistance via the furlough scheme for employees and the self-employment income support scheme for those running their businesses, some tenants fell into rent arrears such that many landlords are currently sitting on losses (although the tenant remains liable for the unpaid rent). How those losses are dealt with taxwise depends on the type of rental property and whether the landlord uses the ‘cash basis’ or the ‘accruals basis’ of calculation.
Profits and losses on property income are calculated in the same way as for a trading business but the letting is taxed as investment income such that the normal reliefs for trading businesses (including those available to offset losses) are not available. In addition, if a landlord has more than one type of ‘property business’, separate ‘pools’ are used for similar types of property i.e. furnished holiday lets, UK and overseas lets are kept separate.
As part of HMRC’s ‘Making Tax Digital’ strategy where an individual landlords’ annual total turnover (gross rents) is less than £150,000, the default accounting method is now the cash basis. Companies and Limited Liability Partnerships are required to use the ‘accrual’ basis (i.e. recognising income received, and expenses paid on an invoice basis, regardless of whether or when the cash is received). However, an individual landlord can ‘opt out’ of the cash basis and use the ‘accruals’ basis by making an election on their tax return. In addition, should the landlord have separate types of property businesses they can opt out of the cash basis for one property business and remain within for another. The ‘opt out’ election takes the landlord out of the cash basis for one tax year only and must be made for each subsequent year as required.
The calculation of profit or loss is undertaken at business level so providing automatic offset if one property makes a loss and another makes a profit. Although the general rule is that losses from a property rental business can only be relieved by carry forward and offset against future profits of the same property business, there is a limited set off available for commercial properties. If there is an overall income tax loss on an individual’s continuing commercial property portfolio over a tax year and that loss has been created by excess capital allowances claimed, then the loss can be relieved by being offset against the owner’s other (‘general’) income for the same and/or next tax year. Otherwise, the loss is automatically carried forward and set against future profits of the same UK property business.
This loss relief may be further restricted because it is only available up to £50,000 or 25% of the taxpayer’s adjusted net income, whichever is the lower.
If a landlord’s other income is less than the personal allowance, the accrual basis of calculation has been used (possibly because the rental income exceeds £150,000) and the loss has been incurred due to capital allowances, then rather than offsetting the total loss against general income in the year of loss, better tax planning would be to disclaim some or all of the capital allowances and carry forward the balance so as not to waste the personal allowance.