BUY TO LET OR FURNISHED HOLIDAY LET? 

Making the most out of your investment property

With 2016’s reduction of tax relief for buy to let properties, the healthy profits you once saw on your buy to let investment (B2L) might seem a thing of the past.  But if your property is in a great area with a strong demand for short-term lets, there is a highly tax efficient alternative. 

A Furnished Holiday Let (FHL) could give you excellent tax advantages over your B2L. Successful FHLs can have higher revenue and higher running costs than B2Ls.  Here we’re purely focusing on tax, but the clear benefits of FHL over standard B2L certainly add up.

We asked Andrew Stanley, Director of STax to explain the differences. So, if a possible tax-free income for many years sounds good to you, read on....

Firstly, what is a Furnished Holiday Let or FHL?

In order to qualify as a FHL, your property needs to be:
  • based in the European Economic Area (or ‘EEA’ – see list of eligible EEA countries)
  • available to rent for at least 210 days per year
  • actually let for at least 105 days per year
  • generally let through short lets of less than 31 days (conveniently, the Nell Gwynn Chelsea Accommodation bespoke booking engine allows bookings to be limited, if so desired, to a maximum stay of 31 nights in order to comply with this element of the qualifying criteria). 
(note these are just the main criteria; detailed guidance from HMRC is available here

The Basics

Here are 4 compelling reasons to consider FHLs:

  1. You can still deduct your mortgage interest: FHLs are exempt from the proposed changes to higher rate interest relief announced in the summer budget. So FHLs will be able to deduct all of their mortgage interest into the future.
  2. Entrepreneur’s relief, or ER: When disposing of a FHL, ER can potentially be claimed meaning that you would only pay 10% capital gains tax as opposed to 18% or 28%! See entrepreneurs relief eligibility
  3. Business property relief, or BPR: BPR is significant because it has the effect of exempting in full or in part the FHL from inheritance tax
  4. Capital Allowances ‘CA’: These are expenses that can be claimed with a FHL on ‘plant and machinery used within the business’.  This old-fashioned wording can sound confusing. Basically it includes loose items in your property like furniture and white goods, and the fixtures and integral features in the building like sanitary ware, electrics, heating, fitted carpets etc.  B2Ls now only get a deduction for loose items that are actually renewed (rather than a set ‘wear and tear allowance of 10%), and no relief is given at all for the first set of expenditure.
If you claim the Capital Allowances (CA) on your FHL you can take your profit out of tax completely for many years.  As there is such a significant saving to be made here it’s worth going into some detail
Capital Allowances (CAs) are a form of tax relief given on eligible items of ‘plant and machinery’.  They reduce your taxable profit and therefore the amount of tax you pay.

For example if you spend £20,000 on furniture each year you get an 18 % writing down allowance which means the profit you pay tax on will be 3,600 less in the first year, which will save a higher rate tax payer £1,620 in year one.  Your remaining capital allowances (£20,000 – £3,600) can be carried into the next year (in this example £16,400) and the process repeats. 

CAs can also be accelerated for recent expenditure using the Annual Investment Allowance AIA (the AIA is currently £200k per annum). This means that in most cases the tax relief is all given in year one rather than bit by bit over a number of years.
So coming back to our FHLs, a proportion of the purchase price (plus legal fees and stamp duty) of a property is deemed to have been to pay for the fixtures that were in place at the time. You are perfectly entitled to claim CAs on these, regardless of how long ago the purchase was. Unfortunately valuing them in a way HMRC will accept is not straight-forward! A claim on these items involves calculating an apportionment (effectively the ratio between the items you can and the items you can’t claim) of the purchase price. Due to the cross-discipline nature of the work (tax and surveying) this requires a specialist firm like STax to undertake the work. 
 

The process of making a capital allowance claim can be broken down into three stages:

  • Initially, a full review of the tax history of the property going back to 1996 is conducted. 
  • Once that is completed, a specially trained quantity surveyor will visit the property to collect site data which can then be used to derive a complete rebuild schedule of the property. 
  • This data would then be analysed by tax specialists to calculate the apportionment and evidence to claim to HMRC. 
This may sound like a lot of work, but beyond opening the door to let the surveyor in, the landlord’s involvement is minimal.
The size of these claims can vary a lot depending on the quality and quantity of items installed, however for FHLs they average around 25% of the purchase consideration. For example you might have £125k of allowances for a property that cost £500k. With the AIA at the elevated level it is, this can create a massive reduction in your taxable profit, or even trigger a tax rebate in some cases.
Imagine a successful FHL that yields 5% taxable profit before allowances. The property was purchased for £500k in 2015, and a CA claim for £125k of CAs made. This gives us taxable profits over time as per the table below.
 
  2015 2016 2017 2018 2019 2020
Purchase consideration £500,000 £500,000 £500,000 £500,000 £500,000 £500,000
Profit % 5% 5% 5% 5% 5% 5%
Profit £ £25,000 £25,000 £25,000 £25,000 £25,000 £25,000
Capital Allowances ‘CA’ -£125,000 0 0 0 0 0
Loss brought forward from n/a -£100,000 -£75,000 -£50,000 -£25,000 £0
Taxable Profit (Profit less CA and historic losses) -£100,000
[i.e. 25k – 125k]
-£75,000 -£50,000 -£25,000 £0 £25,000
Tax payable £0 £0 £0 £0 £0 £25k x IT rate

In this example we have assumed the allowances are fully covered by the AIA.

As you can see no tax is payable until year six by which time the FHL owner has netted £125k of income with no tax due. By comparison, if you hadn’t claimed capital allowances and were a 45% tax payer you would have paid £56,250 on the profits over the same period and that’s without factoring in the impact of the changes to mortgage interest.

The combination of availability of Capital Allowances, the exemption to the changes for higher rate tax relief on interest and capital gains benefits make Furnished Holiday Lets a very attractive alternative to Buy to Lets

Having the correct property management team and the right professional advisers is critical to success with FHLs.
How can we assist?

As detailed before, not only can Nell Gwynn Chelsea Accommodation provide full management for you when your property is placed with us on the short let rental market, but we can also ensure that no booking exceeds the 31 day maximum stay criteria by restricting availability on our booking engine when would-be guests make their on-line reservations. Contact us to find out more.
STax are real estate tax advisors and accountants. They are a professional firm combining qualified tax advisers, accountants and surveyors. They are perfectly positioned to provide a one-stop shop for the tax and accounting needs of those involved in the property sector. They don’t charge for initial consultations and are happy to work on success based fees to give you peace of mind.

So if you are looking to change your B2Ls to FHLs, buy new FHLs, or simply make sure you are claiming everything you are entitled on your real estate holdings, please contact them +44(0)20 7147 9940 for a free appraisal of your position. They charge their tax advisory fees as a percentage of the benefit they deliver, so no tax benefit, no charge. 
 
Disclaimer: The above comments are for guidance only. Owners must seek their own tax advice.  No responsibility for loss occasioned by any person acting/refraining from action as a result of the above information can be accepted by Nell Gwynn Chelsea Accommodation Ltd.