Tax treatment of HMO’s and multi-lets
If you've considered investing in multi-occupancy property either as an individual or via a limited company, it's important to understand the tax treatment of HMO's and multi-lets. This will ensure you maximise any reliefs available and mitigate any potential tax liabilities.
What are HMO's and multi-lets?
Houses in multiple occupation ('HMO's') or 'multi-lets’ are essentially properties that are let out to more than one household. For example, these could be students, young professionals, or singles.
A multi-let may, or may not, be classed as a ‘HMO’. This can depend on the number of bedrooms, stories in the building, and the tenants themselves. The definition can actually vary between local authorities though all HMO owners must be properly licensed.
Properties must meet the new requirements put in place to protect tenants. A failure to obtain a HMO license is subject to criminal punishment.
Reasons to invest in an HMO or multi-let
Generally speaking HMO's and multi-let investments have a higher rate of return than traditional residential buy to let properties. It's therefore possible to earn a decent income from half a dozen HMO's as opposed to 30 or 40 residential buy to let properties.
The only potential downside in investing in these type of properties is that you may not realise the same level of capital gains than for a non-HMO property.
Tax treatment of HMO's and multi-lets
How is income assessed?
The cash basis is now the default method for most property businesses that are run by individuals or partnerships whose income for a tax year is £150,000 or less.
For companies, rental income and expenditure is assessed as trading income the same tax treatment applies to HMO's and multi-lets.
HMO's and Multi-Lets often require refurbishment and structural work in order to optimise the rental capacity of the property. Additionally work may be necessary to ensure the property is the right standard for the local market.
Frequently most spending on HMO's or multi lets may be regarded as a revenue cost. This means it qualifies as either a corporation or income tax-deduction. Capital items, which are added to the acquisition cost for capital gains tax purposes are usually easily identifiable. For example adding an extension, knocking down walls, building an annex etc.
Where expenditure is repairing an existing item, even using modern equivalent materials, it is a revenue cost. A ‘repair’ is generally considered as general day-to- day work needed to maintain the property in order to earn rental income. If a repair is beyond simple repair, or an equivalent replacement, it may be considered capital expenditure.
For example whereas putting new carpet in a property may be allowable, replacing carpet with hardwood or karndean flooring would not qualify as a deduction. In the latter case this would be considered part of the fabric of the building and capitalised.
The boundary between repairs and improvements is frequently a grey area and HM Revenue recognise this. However they have made it clear that where the expenditure changes the character of the thing being repaired it must be classified as a capital improvement, not a repair.
Therefore if an HMO/multi let property is initially not capable of being let any necessary work carried out to place it in a fit state to be let on the open market is unlikely to qualify as a deduction against rental income.
Where work is a combination of capital and revenue and carried out simultaneously, HM Revenue accept that a reasonable and fair apportionment is allowed.
Therefore, it is important to have good records of any expenditure, summarised and receipted. Our suggestions would be as follows:
Unlike the majority of single-let properties you can potentially claim ‘Plant & Machinery Capital Allowances’ on HMO's and multi-lets. Put simply a tax deduction can be claimed on qualifying items within the communal areas of HMOs & Multi-Lets. A proportion of the expenditure associated with these communal area assets, is treated as an expense of the rental business.
Previously landlords attempted to claim allowances on kitchens and bathrooms where these were made into shared rooms within a house. However this opportunity has effectively been closed as a result of a recent tax case won by HM Revenue.
HM Revenue consider where individual rooms do not provide residents with the facilities required for every day private domestic existence, then shared facilities including kitchens, bathrooms and living rooms will not qualify relief (see above).
Whilst this decision now prevents a lot of expenditure from qualifying for capital allowances, it's still possible to claim for items such as plumbing systems, electrical systems, lighting and lifts in common areas such corridors, hallways and basements etc.
If your HMO conversion is small scale it may not be financially viable undertaking a comprehensive review. However for larger scale conversions it could still result in significant tax savings and may be a worthwhile exercise.
One advantage of making a capital allowances claim is that if this results in a 'rental loss' on an HMO or multi let property then this loss can be offset against non-property income. This can potentially result in a generous tax repayment.
Alternatively any 'rental loss', can be carried forward for offset against future rental profits.
Combining HMO's and multi-lets with single-let properties
As a property rental business is treated as a single business for tax purposes, the tax losses made in current and prior years can be used to reduce the tax bill on HMO rental profits.
Therefore if you're a property investor who has accumulated significant buy to let losses, these can be utilised against the profits from an HMO or multi let effectively generating tax-free income.
Additional costs of running HMO's and multi-lets
Typically an HMO landlord includes utilities, broadband and council tax within the rent charged to their tenants. All these costs must be separately identified and reported within the investor tax return. However, these additional costs are fully tax-deductible if incurred ‘wholly and exclusively’ as part of the property rental business.
For more useful information, check out our Ebooks here.
And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].