With the rise of the sharing economy and the shift towards flexible work and lifestyles, many of you are considering turning your residential properties into furnished holiday lets, or FHLs. Perhaps you’ve been inspired by the success of platforms like Airbnb, or you see the potential for higher income from short-term rentals. But before you take the plunge, it’s essential to understand the tax implications of such a move. After all, tax considerations should be a central part of any business decision.
Income Tax Implications
When converting a residential property into a holiday let, the first tax issue that you’ll likely encounter is income tax – specifically, the tax on rental income.
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When you rent out a property as a residential let, the rental income you receive is considered as part of your overall income for the year. This income is taxed at your normal income tax rate, after deducting allowable expenses, such as mortgage interest, repairs, and maintenance costs.
However, when you let a property as an FHL, the rules are slightly different. The income from an FHL is considered a trade, rather than property income. This distinction has several implications. First, it allows you to claim additional types of expenses, such as capital allowances for items like furniture and equipment, which ordinarily wouldn’t be deductible for residential lets. Second, it means that the profits count as ‘relevant earnings’ for pension contributions, which can increase your annual allowance.
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But there’s a catch: to qualify for these benefits, your property has to meet certain conditions under the FHL rules.
Furnished Holiday Letting Rules
To qualify as a furnished holiday let, your property must meet specific criteria set by the HMRC.
First off, the property must be in the UK or the European Economic Area (EEA). It should be furnished sufficiently for normal occupation, and the furniture should be available for the tenants to use.
Most importantly, the property must be commercially let with a view to making a profit. This means you should charge a market rent and not offer heavily discounted or free stays to family and friends.
Furthermore, there are three occupancy conditions that must be met:
- Pattern of Occupation: For at least 210 days in the year, the property should not be occupied by the same person for more than 31 consecutive days.
- Availability Condition: The property must be available for letting as furnished holiday accommodation for at least 210 days in the year.
- Letting Condition: You must let the property commercially as furnished holiday accommodation to the public for at least 105 days in the year.
Capital Gains Tax Implications
Another crucial area to consider is the implication of converting a residential property into a holiday let on capital gains tax.
As most homeowners know, when you sell your primary residence, you usually don’t have to pay capital gains tax due to Private Residence Relief. However, if you convert your home into a holiday let, you may lose some or all of this relief, depending on the length of time you’ve lived in the property and how long it’s been let as an FHL.
On the flip side, converting a property into an FHL can also have some capital gains tax advantages. For instance, you may be able to claim Business Asset Roll-Over Relief if you sell your holiday let and buy another business asset. You might also be eligible for Entrepreneurs’ Relief, which could reduce your capital gains tax rate to 10%.
Mortgage Implications
Lastly, it’s important to discuss the potential implications for your mortgage. While not directly a tax issue, your mortgage terms can impact the overall financial viability of converting a residential property into a holiday let.
Most residential mortgages have clauses that prevent properties from being let out without the lender’s permission. In some cases, you may need to switch to a buy-to-let mortgage, which could come with higher interest rates and stricter lending criteria.
Furthermore, while mortgage interest is an allowable expense for tax purposes, the rules have changed in recent years. For residential lets, the amount of mortgage interest that can be deducted is gradually being reduced, with full implementation set in 2020. However, for FHLs, mortgage interest can still be fully deducted.
Conclusion
It’s clear that converting a residential property into a holiday let is not a decision to be taken lightly. There are numerous tax implications, from income tax and capital gains tax to the rules surrounding furnished holiday lets and mortgage terms. It’s therefore vital to seek advice from tax and financial advisors to ensure that you’re making the right decision for your circumstances and future plans.
VAT Implications
Another significant angle to consider when switching a residential property to a furnished holiday let is the potential implications for Value Added Tax (VAT).
VAT regulations stipulate that residential lets do not qualify for VAT, even if they generate a considerable rental income. However, furnished holiday lets are classified differently, and they fall under the threshold for VAT registration. In the current tax year, the VAT registration threshold is £85,000 of turnover, not profit.
Therefore, if your FHL business’s total income exceeds this threshold, you will be required to register for VAT. With the standard VAT rate at 20%, this could make a significant difference to your profits. On the bright side, once registered for VAT, you will be able to recover the VAT on certain expenses associated with your FHL property, such as repairs, utilities, and maintenance costs.
Do remember to monitor your FHL’s turnover regularly to stay within the regulations. If the property’s annual turnover dips below the deregistration threshold, currently set at £83,000, you may have the option to deregister for VAT.
Long-term Implications and ‘Period of Grace’ Election
As you manage your FHL business, you may encounter years where it’s impossible to meet the letting condition of 105 days due to unforeseen circumstances. Thankfully, the tax regulations offer a little flexibility with the ‘Period of Grace’ election.
If you genuinely intend to let the property but fail to do so for reasons beyond your control (for instance, due to Covid-19 travel restrictions or unexpected property damage), you can make a ‘Period of Grace’ election. This means you can still treat your property as an FHL for that tax year, even though it didn’t meet the strict letting conditions.
To qualify for this election, your property must have met the FHL conditions in the previous tax year. If you don’t manage to meet the letting condition in the following year either, you can make a second ‘Period of Grace’ election. However, if you still cannot meet the letting condition in the third year, unfortunately, the property will no longer qualify as an FHL.
Conclusion
The decision to switch a residential property to a furnished holiday let is far from straightforward and requires careful consideration. From income tax and capital gains tax to VAT and mortgage implications, the complexity of tax regulations can be daunting. Moreover, the need to meet strict FHL conditions each tax year adds another layer of challenge.
Consulting with a tax advisor or financial professional can provide valuable insights into the potential benefits and drawbacks, helping you make an informed decision that aligns with your financial and lifestyle goals. With meticulous planning and management, converting your property into a holiday let can offer a lucrative and rewarding venture.
