Landlords! Should you switch to short-term holiday lets?

Over the past few years the UK government have removed some of the generous tax breaks available to buy-to-let landlords who rented out their properties on long term tenancies.

Higher rate mortgage interest relief is currently being phased out and, by 6 April 2020, a buy-to-let landlord will only be able to claim a 20% tax credit against any tax payable on rental profits.  This means that a landlord paying mortgage interest of £5,000 will be able to deduct £1,000 from any tax payable on their buy-to-let property profits.  Prior to these changes being introduced, a 40% taxpayer would have saved tax of up to £2,000 on the same amount of mortgage interest.

Wear and Tear allowance has also been abolished, which enabled the owner of a furnished let to claim 10% of rental income as a notional expense against their rental income.  This allowance was introduced many years ago to cover the replacement of furniture and white goods and essentially provided a simplified method of claiming these expenses.

In some cases a little bit of simple tax planning can mitigate or eliminate any additional tax payable as a result of these new tax rules.  However, if you are not lucky enough to be in this position and will be lumbered with hefty additional tax liabilities then you may want to consider switching from long-term to short-term Furnished Holiday Lets (“FHL”).  Here are some of the reasons why:

1. There is no restriction to mortgage interest. Therefore, the full amount of mortgage interest should be available to deduct from rental income before calculating tax.

2. Capital allowances are available on the purchase of furniture and furnishings. Compare this to a long-term let, whereby tax relief is now only available when these items are replaced.  This disadvantages new landlords, who might spend large sums on kitting out a property without getting any tax relief until they later replace these items.

3. Profits on an FHL are regarded as earnings eligible for making pension contributions.

4. If the property is jointly owned with your spouse you can allocate the profits as you wish for tax purposes and potentially take advantage of lower tax rates. This flexibility does not apply to long-term tenancies owned jointly between spouses.

5. The disposal of a holiday let property may qualify for Entrepreneurs’ Relief, which means that the capital gain on the disposal of the property will only be subject to 10% tax. However, specific advice should be obtained in relation to your personal circumstances to establish whether you will qualify for the 10% tax rate.

Although you can set up your own website to advertise a FHL, most people use platforms such as Airbnb and Booking.com to market their properties.  There are of course charges for using these companies, but they take away the hassle of having to create your own website.  In addition, a number of letting agents have now entered the short-let market and will manage the entire service for you, including organising cleaning between changeovers.  The professional fees can therefore rack up, but in our experience gross rental income could potentially be more than double that of a long-term let.

So, what are the downsides of an FHL?

• Firstly, if your property is mortgaged, your lender might not give you consent to let the property as a holiday let.
• There is no guarantee of rental income. During off-peak months the property could be empty for long periods.  It really is a case of making hay while the sun shines and maximising income during the peak periods to compensate for the quieter months.
• A holiday let is subject to non-domestic rates. This liability falls on the landlord, but small business rates relief could provide a 100% exemption in certain cases.
• Turnover from an FHL is taxable income for VAT purposes. At the moment the VAT registration threshold is £85,000 and therefore an individual with one or two properties will probably not have to worry about this.  However, if you have a large portfolio of FHL properties then it is entirely possible that VAT registration will be required.  This means either charging the holidaymakers an extra 20%, absorbing the VAT cost, or meeting somewhere in between.  Remember if you are VAT registered you can recover most of the VAT incurred in relation to the property business so it isn’t all bad news.
• A word of warning for anyone who already operates as a VAT registered sole-trader. Any turnover from a personally owned FHL would automatically be subject to VAT.  The same problem could arise if, say, a husband and wife operate a trading partnership and jointly own an FHL.  In these cases some planning work can be carried out to ensure that the FHL income escapes VAT.

The UK government have been consulting over the VAT registration threshold and there is a possibility that this could be reduced in the next couple of years.  The figure of £30,000 has been mentioned in some quarters.  This is by no means guaranteed, but if the threshold is reduced then more FHL landlords will inevitably have to register for VAT.

How does a property qualify as a Furnished Holiday Let?

There are several conditions that must be satisfied for a property to qualify as an FHL.  The key criteria are as follows:

• The property must be located in the European Economic Area
• It must be furnished i.e. there must be sufficient furniture provided for normal occupation
• The property must be commercially let with the intention of making a profit
• The property must be available for letting commercially as furnished holiday accommodation for at least 210 days during the tax year
• The property must be actually let as furnished holiday accommodation for at least 105 days during the tax year
• Normally longer-term lets of more than 31 days do not count towards the days test, unless this limit is only exceeded due to unforeseen circumstances.

In the case of new lets the above rules apply for the first 12 months from when letting began.  Thereafter the rules are considered for each tax year.

If you are interested in operating your property business as a Furnished Holiday Let, or would like to discuss this further, please contact Kenny McNeill on 0131 317 7377 or send an email to kenny.mcneill@jsca.co.uk