Because of the changes to tax relief on interest payments for buy to lets ‘B2L’ many are left looking for ways to improve the tax efficiency of their investments. For those lucky enough to have rental properties in areas with demand for short terms lets there is a highly tax efficient alternative to B2L.
Furnished Holiday Lets ‘FHL’ can potentially deliver significant tax advantages over B2L and in some instances create a tax free income for many years. Read on and we’ll explain how.
Firstly, what is a FHL?
Properties within the European Economic Area ‘EEA’ that fulfil the criteria below are classed under UK taxation as Furnished Holiday Lets ‘FHL’. The main points of the criteria are listed below.
Please note these are just the main criteria, detailed guidance is available on www.gov.uk
Compared to B2Ls, successful FHLs are generally a higher revenue/higher running cost investments. This article is not focused onthe commercial elements of this business, however needless to say like B2Ls, with the right property in the right location (and with the right team around you) there are returns to be made. Of course the inverse is also true. What we are interested in here is the tax benefits of this area of property over standard B2Ls.
Below I have list four compelling reason to consider FHLs below.
1.) Deductibility of mortgage interest: FHLs are exempt from the proposed changes to higher rate interest relief announced in the summer budget. So FHLs will be able to deduct all of their mortgage interest into the future.
2.) Entrepreneur’s relief ‘ER’: When disposing of a FHL ER can potentially be claimed meaning that you would only pay 10% capital gains tax as opposed to 18%or 28%!
3.) Business property relief ‘BPR’: BPR is significant because it has the effect of exempting in full or in part the FHL from inheritance tax.
4.) Capital Allowances ‘CA’: What is not generally known is that a FHL is able to claim CA's on plant and machinery used within the business. This not only covers the loose plant (e.g. furniture, white goods etc) but also extends to the fixtures and integral features in the building (sanitary ware, electrics, heating, fitted carpets etc). B2Ls now only get a deduction for renewals of the loose items, no relief is given at all for the first set of expenditure.
A claim for CA's on the fixtures in a FHL can take the profits out of tax all together for many years. Because of the scale of the impact of this for investors I have expanded further below.
CA's are a form of tax relief given on eligible items of plant and machinery. They reduce your taxable profit and therefore the amount of tax you pay. They are generally given over time in a similar way to depreciation in accounting. CA's can also be accelerated for recent expenditure using the Annual Investment Allowance ‘AIA’ (the AIA is currently £1m per annum). This means that in most cases the tax relief is all given in year one rather than bit by bit over a number of years.
So coming back to our FHLs, a proportion of the purchase price (plus legal fees and stamp duty) of a property is deemed to have been to pay for the fixtures that were in place at the time. You are perfectly entitled to claim CA's on these regardless of how long ago the purchase was, unfortunately valuing them in a way HMRC will accept is not straight forward! A claim on these items involves calculating an apportionment (effectively the ratio between the items you can and the items you can’t claim) of the purchase price. Due to the cross discipline nature of the work (tax and surveying) this requires a specialist firm like STax to undertake the work.
The size of these claims can vary greatly depending on the quality and quantity of items installed, however for FHLs they average around 25% of the purchase consideration, so £125k of allowances for a property which cost £500k. With the AIA at the elevated level it is, this can create a massive reduction in your taxable profit or even trigger a tax rebate in some cases.
Imagine a successful FHL that yields 5% taxable profit before allowances. The property was purchased for £500k in 2015 and a CA survey was conducted and a claim for £125k of CA's made. This gives us taxable profits over time as per the table below.
In this example we have assumed the allowances are fully covered by the AIA.
As you can see no tax is payable until year six by which time the FHL owner has netted £125k of income with no tax due. By comparison, if you hadn’t claimed capital allowances and were a 45% tax payer you would have paid £56,250 on the profits over the same period and that’s without factoring in the impact of the changes to mortgage interest.
The combination of availability of CA's, the exemption to the changes for higher rate tax relief on interest and capital gains benefits make FHLs a very attractive alternative to B2L, of course you do need the right advisors in place.
STax (www.s-tax.co.uk) are real estate tax advisors and accountants. We are a professional firm combining qualified tax advisers, accountants and surveyors. We are perfectly positioned to provide a one stop shop for the tax and accounting needs of those involved in the property sector.We don’t charge for initial consultations and are happy to work on success based fees to give you piece of mind.
So if you are looking to change your B2Ls to FHLs, buy new FHLs or simply make sure you are claiming everything you are entitled on your real estate holdings, please contact us today for a free appraisal of your position. We charge our tax advisory fees as a percentage of the benefit we deliver, no tax benefit, no charge.