Reclaiming tax on allowable expenses

What is an expense?

The instinct most landlords start with is "claim everything". It feels safe, and it feels like you're not leaving money behind. It's the wrong instinct on both counts.

Allowable expenses are the costs you can set against your rental income to work out the profit you pay tax on. HMRC's test is that a cost must be incurred "wholly and exclusively" for running the property business. Get that right and you pay tax on the correct profit. Claim a cost that doesn't qualify, and you've understated your tax, which is a risk if HMRC checks your records. Miss costs you were entitled to, and you've left money on the table. So the goal isn't to claim everything, and it isn't to play it overly safe either. It's to claim exactly what you're entitled to.

The question that decides most of it is whether a cost is a capital expense or a revenue expense. That single distinction is where landlords most often get it wrong, so it's worth getting straight first.

What is a capital expense?

• A capital expense is a cost incurred to buy and upgrade the property.

• Capital expenses can be deducted from the gain (or added to the loss) when selling a property.

Here are some typical capital costs that can be claimed when selling a property.

What is a revenue expense?

• Revenue expenses are costs incurred as part of the day-to-day maintenance of the property.

• They can be deducted from the gross profits at the end of the tax year to arrive at the net profit.

Here's where the line sits in practice. Say a tenant's kitchen is tired and you replace it. If you fit a similar standard of kitchen, restoring what was there, that's a repair and it's a revenue expense you can claim now. If you fit a higher-specification kitchen that upgrades the property, that's capital and you can't claim it against rental income, though you can keep the record for Capital Gains Tax when you sell. Replacing a single-glazed window with the nearest modern equivalent, double glazing, still counts as a repair because the improvement is incidental. The test is always whether you've restored the property or improved it.

Here are some typical revenue costs that can be claimed at the end of the tax year.

What expenses can landlords claim?

Most day-to-day running costs of letting a property are allowable, as long as they pass the "wholly and exclusively" test. A typical landlord expenses list includes:

• general maintenance and repairs that restore the property to its original condition

• water rates, council tax, gas and electricity that you pay

• insurance, such as landlord buildings, contents and public liability policies

• the cost of services you pay for, including gardeners and cleaners

• letting agent fees and property management fees

• accountancy fees

• legal fees for a let of a year or less, or for renewing a lease of less than 50 years

• ground rents and service charges

• direct running costs such as phone calls, stationery and advertising for new tenants

• the business proportion of vehicle running costs, or mileage at HMRC's approved rates

If a cost is part business and part personal, you can claim only the business share, and only where that share is genuinely wholly and exclusively for the property business.

Is landlord insurance tax deductible?

Yes. Landlord insurance is an allowable expense, so you can claim it against your rental income. That covers the usual landlord policies, including buildings, contents and public liability cover taken out for the let property. What you can't do is claim insurance on your own home or any personal cover, because that fails the "wholly and exclusively" test.

Non-deductible costs

The following costs cannot be claimed as an allowable expense.

Replacement of domestic items relief

You can't claim the cost of buying furniture and appliances for a let for the first time, because that's capital. But once those items are in use, replacing them can qualify for replacement of domestic items relief.

For personal tax returns, this relief replaced the old wear-and-tear allowance, which used to give a flat 10% deduction on furnished lets regardless of what you actually spent. That flat allowance was withdrawn. Now you claim the real cost of replacing domestic items instead.

It covers replacing things like free-standing furniture, curtains, carpets and other floor coverings, white goods such as fridges and freezers, and kitchenware such as crockery and cutlery. A few conditions apply:

- it's a replacement of an item already provided, not the first purchase

- the old item is no longer available for the tenant to use

- you claim the cost of a like-for-like replacement, not an upgrade

If the new item is an upgrade, for example a sofa replaced with a sofa bed, you can claim only what an equivalent replacement would have cost, not the extra. A reasonable modern equivalent, such as a more energy-efficient fridge of similar standard, isn't treated as an upgrade, so the full cost qualifies.

Mortgage interest costs

The treatment of mortgage interest cost varies between personally owed and limited company portfolios.

As a limited company, your mortgage interest is viewed as a business expense which can be deducted from your total amount of taxable profit, reducing the corporation tax you’ll pay.

For personally owned portfolios, you'll need to consider Section 24, which means you can only claim 20% of the mortgage interest as an expense.

Section 24 mortgage interest relief

If you personally own a residential buy-to-let property, you will be impacted by “section 24” tax changes, which increased the amount of tax you pay on your rental income.

From April 2021, income tax relief landlords receive for residential property finance costs (mortgages) was restricted to the basic rate of tax.

This means that the amount of income tax paid on rental income will increase as a result, particularly if you become a higher or additional rate tax payer.

As section 24 doesn't apply to limited companies, more higher-rate taxpayers are now using limited companies to manage their tax liabilities.

Allowable expenses and navigating section 24 can be a confusing and complex area for many landlords. If you're unsure about whether a cost can be claimed, ask your accountant or book a consultation with one of our property experts.