What are the tax implications of different UK rental property types?

Many people believe once you start receiving rental income from a property, that is the be-all and end-all.

But that couldn’t be any further away from reality from a tax point of view. UK properties typically fall into 3 categories:

  • Commercial
  • Residential
  • Furnished Holiday Let

Our guide explores what distinguishes each property type from a tax viewpoint, and how this could impact you.

What are the different rental property types within the UK?

Commercial and residential properties are usually rented to the same tenants for a prolonged period. Commercial properties are usually rented to a business for their trade to be carried out from that premises. Residential is typically for a person to live.

However, Furnished Holiday Lets are rented out to a number of different tenants throughout the tax year such as a holiday home. For a rental property to be classed as a Furnished Holiday Let, it must meet certain criteria, which are as follows:

  • Cannot be let to the same tenant for a consecutive 30 days (with exceptions)
  • Property must be available for letting 210 days of the tax year
  • Must be let for 105 days of the tax year

If these conditions are not met, there are elections that can be made to still claim for the property to be deemed a Furnished Holiday Let – Averaging Election & Period of Grace Election.

In the unfortunate event of a loss-making year the losses for Residential, Commercial or Furnished Holiday Let properties can only be offset against other rental income. In very limited circumstances it maybe possible to offset an element of a furnished holiday let loss against other income

Expenses – Revenue Vs Capital

Landlords will incur a variety of expenses whilst renting out a property, some will relate to the day-to-day running and maintenance of the property, and others will be incurred on the sale or purchase of the property or to enhance the property. These will all have different treatments for tax purposes and will determine when relief for these expenses can be claimed.

Expenses which are incurred in the day-to-day running of the property can likely be deducted from the rental income of the tax year in which it relates. Examples of these could include; a TV licence, broadband and general repairs. If the property is deemed a Furnished Holiday Let, you may also be able to claim any refreshments you provide for the occupier on arrival.

You may incur other expenses whilst dealing with the sale or purchase of a property. The legal fees and estate agents’ fees will not be deductible against the rental income. Instead, you will obtain relief by deducting these against the sale proceeds of the property when you come to sell, we call this capital expenditure. Any expenditure which enhances the value of the property will also be deductible against the sale proceeds of the property rather than the rental income.

A ’like-for-like’ replacement or the modern-day equivalent will however be deductible against the income. For example, replacing Single Glazed Windows with Double Glazing. Whilst this is an improvement to the property, as double glazing is the modern standard for windows the expense can be offset against income.

An advantage of Furnished Holiday Lets is the ability to claim capital allowances. This allows for certain capital expenditure to be deducted against the rental income. The expenditure will be deducted at either 18% or 6% on a reducing balance method. However, if the relevant criteria is met, the expenditure may qualify for a 100% deduction through the ‘Annual Investment Allowance (AIA)’ or ‘First Year Allowance (FYA)’.

Capital Gains Tax

When you come to sell the property, Capital Gains Tax may be due. Commercial, Rental & Furnished Holiday Lets all have slightly different tax treatments when sold.

If a Residential property is sold, and there is a taxable gain, the gain will be taxed at 18% up to the basic rate band, and 28% thereafter. So, if you are a higher-rate taxpayer, your capital gain will be taxable in full at 28%.

It’s important to remember the 60-day reporting requirements of taxable gains arising on the sale of a residential property.

Commercial properties are very similar, but the rates gains are taxed at are 10% up to the basic rate band and 20% thereafter.

Capital Gains on Furnished Holiday Lets are taxed at the same rates as Residential properties, 18% & 28%.

However, they have scope to qualify for Business Asset Disposal Relief (BADR). BADR allows for gains to be taxed at 10%. To quality for BADR, the property must have been a Furnished Holiday Let for at least 2 years prior to the sale.