Posted by Simon Misiewicz on 8th July 2013
Do you buy properties that need refurbishment works? Would you like to use the latest know how to reduce your tax bill through capital allowances?
There are many people that are buying properties as an investment. There are many landlords and property investors that have accountants.
The sad thing is that their accountants could be of greater use of landlords and property investors involved them in the buying process.As it is a tax question whether expenditure is capital or revenue, accountancy has no role in deciding whether or not an expense is allowable.
Where accountancy is important is that the accounts, prepared in accordance with GAAP, determine when relief is given for tax purposes (1).
As such landlords and property investors are likely to be paying more tax than they need to on their property investments.
If you are paying tax then read on…There are two types of costs that we will consider throughout this article:
- Capital costs
- Revenue costs
As you may appreciate revenue costs may be offset against your profit and is therefore reduces your tax liability. A capital cost is an asset and is therefore part of your balance sheet. These costs are depreciated over a number of years but only where it is a commercial property. Residential properties are not allowed to depreciate their assets to reduce future tax liabilities (4).So what are capital costs and revenue costs? (2)
Capital costs (depreciated over a number of years)
- Replacing assets If you are replacing an entire asset rather than repairing assets such as a kitchen suites, bathrooms suites, fencing etc, these costs are not considered a repair and therefore needs to be capitalised as an asset (3)
- Improvement /alteration / technology cost: Where any improvements are made to an asset such as a new kitchen with greater features or a conservatory, then these costs are an improvement of the asset as a whole and are therefore capitalised costs that benefit from 18% capital allowances each year. Examples of improvements are:double glazed windows from single glaze, electrical system with alarms that did not have one before.
- If something is ‘a fixture’ then it has become part of the building and not an asset in its own right (1).
The type of costs that are considered to be capital costs of a residential building are:
- Kitchen suites
- Bathroom suites
- Electrical systems
Revenue costs (tax deductible)
- Replacing assets: whereby you are replacing an element of an asset such as an oven door, parts of existing brickwork, replacing tiles on a roof (3) as these examples are part of the an existing asset and not an asset in its own right.
- Integral features: are sometimes repaired or replaced. Item such as kitchens, bathrooms suites, fencing whereby the total cost of the replacement / repair is more than 50% of the original cost are to be considered a capital cost.
The following items of costs cannot be considered as a repair or capital and therefore will not form part of a tax reducing cost:
- Fridges / freezers
- Furniture and related fixtures
- Temporary fixtures
Here are some examples given by HMRC (1)
Amy owns a Victorian building that has been divided into student flats.The electrician recommends that the building needs re-wiring. Amy decides to take the opportunity and have the building modernised.The whole house is rewired, the heating system is partially replaced; the kitchens in all flats are replaced, together with two of the bathrooms. Three windows are replaced and the property re-decorated inside and out.As a result of the work, Amy still has a property divided into the same number of student flats, capable of providing the same standard of accommodation for the same number of students.
Looked at as a whole, the character of the asset has not changed as a result of the work. There may be small items of alterations, but the overall programme is simply a repair. As the property is a dwelling house, it does not qualify for capital allowances and so the integral features rules do not need to be considered.
For further guidance on the meaning of ‘dwelling house’ see the capital allowances manual CA11520. Amy’s property lies in an area that is attracting investment. Rather than refurbishing the property as student accommodation, Amy has the same work carried out to a higher standard and converts the building into flats suitable for long term letting to people in a high income bracket.Looked at as a whole, the character of the asset has changed, from short let student accommodation to up-market long term lettings.It is important to recognise that a considerable amount of work that can be carried out without changing the character of the asset.
Sophia owns a number of residential properties that she lets. The properties are not furnished lettings.
The boiler in one property needs replacing. As the new boiler has to be located in a different position, Sophia decides to modernise the kitchen as a whole.All the existing base units, wall units and sink etc are stripped out and replaced, as is the fitted cooker and hob. New units of an equivalent quality are installed but in a different layout to allow for the re-location of the boiler, finally the kitchen is re-plastered and re-tiled.The entirety is the house, not the fitted kitchen. The new kitchen is slightly different but it does the same job as before. Sophia has simply replaced the old kitchen with a modern equivalent. This is a repair and allowable expenditure.Shortly afterwards, the fridge freezer breaks down and has to be replaced.
This is not part of the building but is an asset in its own right. Sophia has not repaired an asset; she had incurred capital expenditure on a new asset. As the fridge freezer is used in a dwelling house it is not qualifying expenditure for capital allowances purposes.
A Ltd company trades from premises that consist of a showroom and warehouse. They decide to modernise their premises. They completely renew the roof; refurbish the staff kitchen; they extend the showroom by demolishing an interior wall and building a new one and installing a new floor and false ceiling to modernise the extended showroom area.The new roof simply returns the roof to original condition. It is neither an alteration nor improvement; it is simply a repair of the building. In the same way, the refurbishment of the staff kitchen is simply a repair of the building. These are allowable expenses.
Rosemary runs a property business. One of the houses needs repairs to the roof. Rosemary takes the opportunity to convert the attic into an additional bedroom.Rosemary has chosen not to simply repair the property; she has altered the property by converting unusable space into another room. The whole of the cost is dis-allowable.
Helena has a property business. She is advised that the boiler in one property needs to be replaced.Helena is told that she cannot simply replace the boiler with one of the same type because since 1st April 2007 it has been a legal requirement (in England and Wales) that all gas boilers installed must be a condensing model. In addition the old boiler was rated in Imperial units and boilers are now measured in the equivalent metric unit.Helena chooses to replace the boiler with a condensing boiler that is the closest equivalent in capability.
The new boiler is smaller and has to be installed on a different wall, so that it can condense outside. Helena takes the opportunity to install additional kitchen units as tenants have commented about the lack of storage space.Although the tank is slightly larger, the reality is that Helena has simply used the modern equivalent of the original tank. The result is that the cost of the boiler is still revenue expenditure. The cost of the additional kitchen units is an improvement and not an allowable expense.End of examples.There are many examples that demonstrates that any cost associated with a property falls into
- Capitalised expenditure (adds value or is new to the property)
- Revenue expenditure to reduce tax (direct replacement / repair)
- Non capital / revenue expenditure (fridge example)
HMRC remind you that it is not the responsibility of your accountant to understand or apply the above rules. HMRC are very strict in saying that the responsibility of applying the above rules are of the property investors / landlords and no one else. If you would like to talk the above details through then please call me for a free 30 minute consultation.
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