Furnished Holiday Let or traditional buy-to-let? Tax advantages outlined…

As well as providing you with a potentially valuable revenue stream, a Furnished Holiday Let (FHL) can also carry certain tax advantages when compared to other types of rental property. So what are those advantages? How does a property qualify for FHL status in the eyes of the taxman? We take a look…

 

Why is FHL a special case for tax?

A property rental business is generally treated as an investment activity. This means that the various reliefs and allowances available to trading businesses are mostly out of bounds to landlords.

But for a holiday homeowner, your property is something more than a pure investment. You intend to make a living from it (by providing a self-catering accommodation service to holidaymakers). HMRC recognises this. So whether it’s a house, cottage, flat — (or even the likes of a static caravan or yurt) — if your property rental business meets the criteria of Furnished Holiday Accommodation, it can open the door to some of the tax advantages generally only available to trading businesses.

The qualification rules

To benefit from this advantageous tax treatment, your holiday home must meet the following criteria:

  • It must be located within the European Economic Area
  • It must be let on a commercial basis with the intention of making a profit (as opposed to occasional lettings to friends and family with a basic rent to cover expenses, for instance)
  • It must be furnished
  • It must be available for a minimum of 210 days (30 weeks) in a calendar year
  • It must generally be let out to the general public for at least 105 days (15 weeks) over a calendar year.
  • Longer-term occupation (i.e. let out to the same guests for more than 31 consecutive days) cannot add up to more than 155 days in a 12-month period
  • If you have more than one FHL property, occupation requirements for each property can be calculated as an average of the totals for all letting properties. It means that if you fall just short of the requirements on one property, other properties might help you get over the threshold requirements. Averaging rules also apply over different years.

Fully offset your interest costs

Firstly, the bad news for traditional BTL landlords: starting April 2017, a 4-year phase-in has commenced, at the end of which the cost of finance (i.e. mortgage interest and costs connected to this such as fees and commissions) will no longer be deductible when calculating your rental profits. In its place is a new scheme, whereby only basic rate tax relief (currently 20%) will apply to finance costs incurred.

Now, some better news: the change applies to residential property — and is clearly aimed at curtailing the traditional buy-to-let market. Crucially, it doesn’t apply to qualifying Furnished Holiday Lets.

How will the new rules work?

Let’s say you own a residential property. You have a long-term tenant in place and from this, you earn rental income each year of £24,000. You have typical maintenance costs each year of £4,000 and mortgage interest payments of £12,000.

Under the old rules, your rental profits would be assessed at £8,000 (i.e. rent, minus maintenance costs and also minus interest payments). But once the new rules are fully in force, interest payments are excluded, meaning that your profits would be assessed at £22,000. It’s clearly a significant jump.

Ultimately, for every £1 of finance costs incurred by a landlord, they will be able to claim 20p tax relief — a big difference to the previous system where you got relief at your marginal rate of tax.

What does it mean for traditional BTL landlords?

Let’s say you are currently a basic rate tax payer. Once mortgage interest payments are no longer taken into account to work out taxable profits, you may find that you are now a higher rate taxpayer. Depending on your circumstances, the knock-on effects of this could be considerable. For instance, it may affect your tax credits claim, or that capital gains are now taxed at 28% instead of 18%.

More widely, operating as an FHL landlord — as opposed to holding a regular BTL investment — may start to look considerably more attractive. For one thing, a serviced accommodation model can result in significantly higher gross receipts compared to traditional residential tenants. What’s more, subject to you meeting the FHL qualification criteria, you can continue to fully offset your interest costs.

BTL v FHL: a worked example

For a side-by-side comparison of a BTL or FHL business model, we’ve taken a property with a value of £340,000 (held by an individual rather than by a company).

Note the following:

  • For FHL, the gross revenue is 60% higher than traditional BTL (£32,640 compared to £20,400).
  • Running costs for the FHL are markedly higher than the BTL (taking into account expenses such as online platform fees and other ‘marketing’ costs, higher utilities fees, business rates and maintenance costs).
  • Despite the higher running costs, FHL net annual revenue (£24,480) remains significantly more attractive than the figure for BTL (£17,340).

So what happens when we take into account the upcoming finance cost relief changes? The FHL model looks even more appealing…

The tapering of tax relief for finance costs, phased in over a 4-year period, means that BTL landlords are going to see their profits progressively squeezed. Ultimately, the government estimates that this will result in £665m annually going from landlords into the Treasury’s back pocket.

Back to our example

Once you take into account the interest costs and what you can offset under the two models you are left with a real net profit as highlighted in the graph.

Over the 4-year period your comparative net profit is substantially different. A BTL would earn 14,616 v a FHL earning you 35,530. Expect the buzz around this space to get bigger and bigger over the next few years.

The other tax advantages: an overview

Making your property “holidaymaker-friendly”

For regular BTL property investments, the cost of kitting out the property to make it rentable cannot be deducted from pre-tax profits. For FHL however, Capital Allowances can be claimed for fixtures and integral features. So for buying things like cookers, fridges TVs and carpets, the cost can be deducted for Income Tax purposes.

Pension contributions

Unlike ordinary lettings businesses, FHL profits are classed as “relevant earnings” for pension contribution purposes. This raises the possibility of tax-advantaged pensions savings from your holiday lettings income.

Profit-splitting

With a regular lettings property, profits are distributed in accordance with the legal ownership split — so if you and your spouse own 50% of the property, you each share 50% of profits — or losses. With FHL, there’s the possibility of allocating profits in any proportion required (useful for making full use of personal allowances).

Selling the property

Capital Gains Tax reliefs aren’t generally available on the sale of long-term BTL properties. However, the sale of an FHL property raises the possibility of several reliefs:

  • Roll-over relief: chargeable gains can be deferred if you are buying a new FHL property.
  • Hold-over relief: chargeable gains on a gifted FHL property can be deferred.
  • Entrepreneur’s relief: taxable gains from qualifying property can be charged at the low rate of 10%.

So what next?

For further information on the wide range of benefits associated with Furnished Holiday Letting Accommodation and the full lowdown on the various reliefs available, follow CopoFi on Facebook.

This has been produced by CopoFi for general information only and is not intended to constitute professional advice. Specific professional advice should be obtained before acting on any of the information contained herein. Whilst CopoFi is confident of the accuracy of the information in this publication (as at the date of publication), no duty of care is assumed to any direct or indirect recipient of this publication and no liability is accepted for any omission or inaccuracy