Sometimes the answer in difficult financial times lies close to home. In many cases, it lies in the spare room.
The number of people letting out rooms in their homes has grown rapidly over the past two years. Yet while rent from a lodger can be a valuable way to supplement your income, a nasty surprise may lie in store – thanks to HM Revenue & Customs.
If you let a furnished room or rooms in your own home, some or all of the income may be exempt under the “rent a room relief” provisions.
To qualify for the relief, you must occupy the property as your main home at the same time as the tenant for at least part of the tax year. The relief is available for owner-occupiers as well as tenants, although the latter should check their lease allows them to sublet the property. For homeowners it’s important to advise your mortgage provider and insurer if you are taking in lodgers.
The relief does not apply to rooms let as an office or for other business purposes.
No tax is payable where the rental income in a tax year, before deducting expenses, does not exceed £4,250. Rental income includes rents and any income from the provision of services such as meals or laundry.
If the rental income is split between a couple the relief is £2,125 each, although if there are more than two individuals they would each be entitled to £2,125.
Where the rental income for the tax year exceeds £4,250 ,you can choose to pay tax on the excess over £4,250 or on the rent less allowable expenses, whichever is most beneficial.
Allowable expenses are those that are revenue rather than capital in nature and are wholly for the purpose of the letting. These include council tax, insurance, advertising for tenants, loan interest, repairs and maintenance.
You can claim for the rent a room relief not to apply for a particular year if your expenses exceed your rental income, as you can claim relief for the rental loss. It should be noted that the use of a rental loss is limited and can only be used to reduce other rental income in the tax year or can be carried forward against future rental profits.
If you don’t normally prepare a tax return and your receipts are below the tax-free threshold, the tax exemption is automatic and no tax return is required. If your receipts are above the limit or you wish to disclaim the relief, you will need to complete a tax return.
The capital gains tax (CGT) relief available on the sale of your main residence will not be affected by taking in lodgers if the letting takes the form of boarders who effectively live as part of the family.
If this is not the case, the last three years of ownership will be exempt from CGT under the normal Principal Private Residence (PPR) rules. If the letting occurred outside the last three years, PPR lettings relief will be available. Lettings relief exempts the lower of £40,000, the pro-rata gain arising on the gain attributable to letting or the gain exempt under PPR.
• Ronnie Ludwig is a partner at Saffery Champness chartered accountants in Edinburgh