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Property rental businesses are generally treated as a form of investment activity rather than as a trade. The result of which is that businesses are ineligible for a number of tax advantages and reliefs. Where any property rental business meets specific conditions to qualify as a furnished holiday let (FHL), they can claim some of the tax advantages that are normally only available to trading businesses. HMRC set out their guidance on the tax treatment of FHLs at gov.uk. In order to help you understand the position better, we’re here to help provide the best advice on FHLs.
The advantageous FHL treatment applies to most self-catering types of accommodation, which can be a house, cottage, flat, suite of rooms, caravan, or even a yurt, so long as it meets the specific conditions.
What is a furnished holiday let?
To qualify as a furnished holiday let, the property must meet four conditions:
- The location of the accommodation must be within the European Economic Area (EEA). This includes the UK, all EU member states, plus three of the four European Free Trade Area (EFTA) states: Norway, Iceland, and Liechtenstein. There are many European countries that do not qualify. These include Switzerland, the Channel Islands, the Isle of Man, Gibraltar, and Northern Cyprus – only the South is an EU member. Property in some other overseas’ territories may qualify, but it is a complicated matter and advice should be sought.
- The accommodation must be on a commercial letting basis and with a view to making a profit. Sometimes this can be difficult to prove. Although, with the help of an accountant, preparation of a business plan and profit-and-loss or cash-flow projections should satisfy this requirement. The plans and figures must show that there is a reasonable expectation that a profit is feasible from the letting(s). Whilst there may be losses in the early years of a new venture, this is not fatal to a claim for FHL treatment- only if there is a likelihood of profitable growth in subsequent years.
- Furnished accommodation is a requirement. The expected minimum is beds, seating, a table, cooking and washing facilities, and storage, suitable for the size and type of accommodation.
- The final condition relates to the potential and actual occupation of the accommodation during the ‘review period’. This is always a 12-month period; usually the tax year from 6 April in one calendar year to the following 5 April. However, different periods may apply on commencement or cessation of the letting business.
The occupation requirements
During the 12-month review period, the accommodation must:
- Be available for commercial holiday letting to the public for at least 210 days (30 weeks); and
- Let commercially as holiday accommodation to the public for at least 105 days (15 weeks); and
- If occupied by the same person(s) for more than 31 days, have a total of no more than 155 days of such longer-term occupation.
If there’s more than one FHL-type property in operation, a calculated average of day let totals for each property may satisfy the minimum day totals. Therefore, if one property fails to meet the conditions it may be ‘buoyed-up’ by the other properties.
Failing to meet the occupation condition
It may be difficult to meet the occupation condition every year. Once a property has acquired FHL status it will retain it even if it fails to meet the actual occupation condition for two consecutive tax years. A property must meet the occupation condition at least once every three tax years to continue to be eligible.
What are the tax benefits for furnished holiday let owners?
- Profits from an FHL business are relevant earnings for pension contribution purposes. This means that tax advantaged pension savings are in respect of such profits. Ordinary letting business profits do not qualify for this.
- It is possible to claim capital allowances for capital expenditure incurred for a furnished holiday let business. This could include cookers, fridges, televisions, sofas, tables, chairs, beds, curtains, carpets, etc. As well as fixtures such as heating, lighting, electrics, bathrooms, and kitchens. Normal letting businesses are unable to claim capital allowances on this sort of expenditure.
- Following the sale of an FHL property, you can claim capital gains tax (CGT) reliefs, which is normally only available to trading ventures.
- Business asset disposal relief – permits CGT at the rate of 10% charged to a qualifying FHL business. Gains not eligible to this relief are subject to a CGT rate of either 18% or 28% depending on the level of an individual’s income and the size of the gain. Only the first £1 million of an individual’s relevant lifetime capital gains can qualify for business asset disposal relief. There is a 60-day reporting and CGT payment requirement on the disposal of UK residential property.
- Roll-over relief – allows deferral of specific chargeable gains upon the acquisition of new trading assets. Deferral of gains on the sale of FHLs using this relief, and the acquisition of an FHL property, can count as a new trading asset, which allows the deferral of gains on other qualifying assets.
- Hold-over relief – allows the deferral of chargeable gains that would otherwise arise on a gift of the property.
If a spousal partnership operates an FHL, they can divide the profits in any proportion desired – regardless of the actual ownership shares. For an ordinary property letting business, this is not the case. In the absence of evidence of the ownership shares, the profits are equally divided.
In November 2022, the Office of Tax Simplification (OTS) issued a report on the review of property income taxation. That report suggested the abolition of the special FHL regime. It is not yet clear whether the UK government is likely to take any action in response to the OTS report.
Other tax issues for furnished holiday lets
A loss incurred by an FHL business in any tax year is not available for set-off against any other types of income or gains. It is only possible to carry forward such a loss to the next tax year and offset it against future profits of the FHL. UK-based FHL properties and EEA-based FHL properties are both treated as entirely separate businesses. A loss on one cannot be offset against the other.
Inheritance tax (IHT)
There is no special treatment for FHL properties under IHT. The market value of any FHL property (net of mortgages) will normally fall within an individual’s estate and will be subject to IHT in full.
For an FHL to qualify for business property relief (BPR), it must be evident that the operation of the FHL amounts to a business. Then, it is necessary to show that it is not an investment business, which requires a demonstration of services. HM Revenue & Customs (HMRC) are notoriously averse to permitting BPR claims on FHL properties.
Value Added Tax (VAT)
An FHL business is within the scope of VAT. If the total turnover of an individual running an FHL business exceeds the VAT turnover threshold (£85,000 per year), it is compulsory to register the business for VAT. Standard rate VAT is chargeable on FHL letting income (currently 20%), and it is necessary to submit VAT returns. VAT suffered by the FHL business (input tax) would be recoverable by offsetting against the VAT charged on letting income (output tax).
The registration limit is not applied on a business-by-business basis. It relates to all the business activities undertaken by a particular taxpayer. Employments and other investment income do not count. For example, if a VAT-unregistered individual has a shop with a turnover of £80,000 and acquires an FHL, which turns over £7,500, they will breach the turnover threshold. The individual will have to register, bringing both the shop and FHL within the scope of VAT.
There may be an aversion of compulsory registration if one business was a partnership operation (e.g., spousal joint ownership) and the other as an individual’s activity. HMRC have powers to aggregate businesses together if they believe the business arrangements are a motive for tax avoidance.
If self-catering accommodation is available for short-term lettings totalling more than 140 days in a year, it will be subject to non-domestic rates (business rates). Thus, all FHL qualifying properties in the UK are subject to this local property tax. The basis of which is on a property’s estimated annual rental income. Different local authorities apply different reliefs and so reference to each property’s authority is necessary. Read our “Simplifying income tax for residential landlords” blog post for more information on this.
What expenses can you claim?
The rules for calculating taxable business profits when working out the profit or loss on an FHL business must apply.
The two most important general rules are:
- To be allowable as a deduction, incur an expense ‘wholly and exclusively’ for the purposes of the FHL business. If the owner uses the FHL or allows friends and family to use the FHL at a reduced rate, there will be a restriction on the property expenses.
- To be allowable as a deduction, an expense cannot be ‘capital’ in nature. Capital expenses are one-off expenses on the original construction, purchase, or improvement of a property. Some capital expenditure on equipment may qualify for capital allowances, which will grant up to 100% deduction for the capital cost of an item. Sale of the FHL property might arise chargeable gains that are liable to CGT. You should record capital expenses and keep any invoices against these costs.
More specifically, allowable expenditure against FHL profits will include:
- Management or agency fees for letting
- Advertising (including website maintenance) to attract guests
- Membership of FHL owners’/other relevant trade associations
- Maintenance and cleaning of FHLs
- Insurance relating to the FHL business (e.g., buildings, contents, public liability, employees)
- Accountancy and other on-going, non-capital professional fees (e.g., debt collecting)
- Interest on loans and borrowings to acquire or improve an FHL property
- Rates, water rates, refuse collection costs and other similar local government charges
- Repairs to the property
If an owner is not a UK resident, the obligations of the Non-Resident Landlord Scheme (NRLS) still apply to FHLs. Therefore, it is particularly important that non-resident owners comply with all the requirements of the NRLS, as well as the tax position in their own country of residence.
If you have any queries on FHLs, please get in touch. If you have a query on purchasing a property, do not hesitate to contact a member of the SDLT team.