An investment property is defined in the Glossary to Financial Reporting Standard FRS102 as:
“Property (land or a building, or part of a building, or both) held by the owner (or by the lessee under a finance lease) to earn rentals (regular income) or for capital appreciation or both”
Property which is held for use in the ordinary course of business (i.e. for the production or supply of goods or services or to perform administrative processes) will not meet the definition of investment property. Additionally, where an entity holds property for sale in the ordinary course of business this, too, will not meet the definition of investment property.
Landlords of an investment property may be companies, individuals, or trusts, who let residential property. Following recent tax changes, the majority of such investments are currently made via a Limited company as a separate entity to the individual considering the investment. This is currently commonplace for buy to let investments for rental income.
When a property meets the definition of ‘investment property’, it is initially recognised as a capital investment cost: the purchase price plus all directly attributable costs (which may include legal fees, stamp duty and brokerage fees).
Companies pay tax on their profits from rental income at the rate of corporation tax. Individuals should note that any revenue that you receive from residential lettings and furnished holiday lets counts as taxable income. You can reduce your tax liability by making sure that you calculate your profits correctly and claim back allowable expenses to reduce your tax bill (see later).
As you or your company must pay tax on the profit you make from renting out the property, your record keeping is important.
In terms of record keeping, you will need to keep accurate records including receipts, bills and invoices that show the date and the amount:
- you paid for an asset
- of any additional costs like fees for professional advice, Stamp Duty, improvement costs, or to establish the market value
- you received for the asset - including things like payments you get later in instalments, or compensation if the asset was damaged
Also keep any contracts for buying and selling the asset (for example the completion statement from your solicitors) and copies of any valuations.
A question that we are often asked is: How do you consider whether the cost is allowable expenditure or an investment in the asset?
The general position is that the cost of:
- a repair is normally allowable expenditure, but
- replacing the asset or of making a significant improvement to the asset as a whole (the 'entirety') will be capital expenditure and not allowable as a deduction.
- Replacing a part is a repair to the larger asset, replacing the whole asset is not a repair, and is not an allowable deduction for tax purposes because it is capital expenditure.
The fact that a repair might be significant and involve considerable financial outlay does not prevent it from being revenue in nature and turn it into a capital item. The test remains whether the expenditure is incurred in restoring the property to its original condition (revenue) or enhancing it (capital).
Here are some examples:
Repair / Expenses
Allowable expense should be ‘wholly or exclusively’ incurred as part of a landlord’s rental business.
- Repairs or ‘revenue’ expenditure is what is incurred merely to preserve or maintain an asset. Any Painting and Decorating between tenants or re-decoration (not improvement)
- Replacing tile of a roof
- Stone cleaning, re-pointing
- Damp / Rot treatment
- Repairing water or gas leaks, burst pipes
- Repairing electrical faults
- The repair of broken windows, doors, furniture (Replacing a part of the property with the nearest modern equivalent is still a repair if the improvement is incidental to the repair, such as replacing a single-glazed window with a double-glazed window, however other rules may apply)
- Replacement with modern material providing no improvement of load, pressure, heat, (e.g. wooden beams with steel girders or lead pipes with copper or plastic pipes.)
- The repair of appliances, such as cooker, fridge, boiler,
- Replacing of guttering
- Unblocking a drain
- Services provided such as cleaning or gardening
+ Landlord buildings insurance, letting agents’ fees, accountancy fees, council tax
The Replacement of Domestic Items relief (for expenses after 6 April 2016).
If you let out residential property (a dwelling house) you may be able to claim a deduction for the cost of replacing domestic items such as movable furniture (e.g. beds, wardrobes), furnishings (e.g. carpets, curtains, linens), household appliances (e.g. televisions, fridge, freezer) and kitchenware (e.g. crockery, cutlery). Tax relief is given against their rental income for the cost of the replacement item, less the cost of any element of improvement (beyond the nearest modern equivalent). Relief is not available if rent a room relief is claimed, to holiday lets or if capital allowances are claimed.
Investment / Asset or Capital Improvement expenditure
Capital expenditure is incurred broadly when the result is a permanent or long-lasting enhancement to an asset, or its outright replacement. Capital expenses aren’t allowable and can’t be claimed against your rental income but you should keep records of them as you might be able to set them against Capital Gains Tax if you sell the property in the future.
- The cost of land and any buildings on it
- Adding an extra bedroom (or something that was not there before)
- Upgrading the kitchen units to a higher specification (or alter, improve, or upgrade something that was existing)
- The purchase of furnishings and equipment for the property (to furnish an unfurnished property for inclusive rental)
- Converting a loft or disused barn
- Installing a new security system
- The cost of refurbishing or repairing a property bought in a derelict or run-down state
+ Professional fees paid to assist with the purchase or sale of the property (e.g. legal, surveyor)
In many cases it will be clear (the like for like test) whether the expenditure relates to a repair or to an improvement, however in some cases the boundaries can become blurred and we recommend you seek professional guidance from your accountant or bookkeeper.
A couple of other tax considerations:
You are required to pay Stamp Duty Land Tax (SDLT) if you purchase a property over the SDLT threshold in England and NI. That threshold is currently £125,000 for residential properties and £150,000 for non-residential land and properties.
When you sell your property the individual/s or company as an entity is liable for Capital Gains Tax on any profits made over and above the Annual Exempt Amount. Costs you can deduct include costs to improve assets (but not normal repairs).
Accounting rules require Deferred Tax to be brought into account for investment properties using the tax rates and allowances that will apply to the sale of the asset.
Nb. This article assumes a property located in the UK, with the landlord of UK residence.
HMRC reference links