The much-publicised new licensing scheme for short term lets may result in the tax benefits available to owners being ever more important in determining whether to continue to let a property as holiday accommodation. The benefits are available only if certain tests are satisfied, so we’ve reviewed whether they remain an attractive investment proposition from a tax perspective.
Unlike other rental property, income and capital gains arising from furnished holiday lets may qualify for several potentially valuable income tax and capital gains tax (CGT) reliefs that are normally only available to trading businesses.
To benefit from these reliefs, however, there are certain conditions that must be satisfied.
Firstly, the property must be in the UK or the European Economic Community (EEC). The business of running it must be carried on commercially, with a view to a profit. It must be available for short-term commercial letting to the public as holiday accommodation for at least 210 days in the tax year or accounting period and must be commercially let for at least 105 days in the same period.
Where the letting condition is failed for a tax year despite the taxpayer’s best efforts to let the property, a period of grace election can be made. An election allows your property to continue to be taxed as a furnished holiday let even if you didn’t meet the minimum letting condition of 105 days in that year. However, you must be able to show that you had a genuine intention to let the property as a furnished holiday let, and that you met the letting condition in the previous year. You can make a ‘period of grace’ election for up to two consecutive years, but if you fail to meet the letting condition for a third year, your property will no longer qualify as a furnished holiday let.
If your holiday home or seaside cottage meets the necessary conditions, then losses arising from it can be offset against future profits from the letting business. The restrictions to income tax relief to the basic rate of income tax (20%) for interest paid on borrowings of residential landlords introduced from 6 April 2017 do not apply to qualifying furnished holiday lets. When interest rates are high the ability to obtain a deduction for interest paid at income tax rates of up to 47% may generate considerable tax savings. Finally, the profits from your letting business may also increase the level of tax-efficient pension contributions you can make in the tax year.
If the property is sold in the future at a profit, then the payment of any capital gains tax liability can be postponed by reinvesting the proceeds in other qualifying business assets until these too are sold. Capital gains arising on the gift of a furnished holiday let can also be postponed until its future disposal. Finally, Business Asset Disposal Relief may be available to reduce the effective rate of capital gains tax from 18%, 28%, or a combination of both, to 10%.
For completeness, it should also be noted that if your property is available to let for 140 days or more, and actually let for 70 days or more a year then you may be chargeable to business rates (potentially qualifying for small business rates relief) rather than council tax. There are different rules if your property is situated in England and Wales.
While the transfer of assets with a value in excess of your available IHT nil rate band (which for 2023/24 is £325,000), either during your lifetime or on your death, could be subject to a 40% inheritance tax (IHT) charge, furnished holiday lets that qualify as business assets attract 100% business relief, which could effectively remove their entire value from your estate for IHT – a fact that hasn’t gone unnoticed by HMRC.
It should not be assumed that furnished holiday lets which qualify for the special income tax and capital gains tax treatment will automatically qualify for business relief. The statutory tests for income tax and CGT do not apply for IHT.
The renting-out and management of the property alone will not be treated as a business for IHT relief. HMRC will scrutinise the level and type of services being offered by the owner and it has indicated that additional services being offered to guests would have to be comparable, for example, to those received in hotels or some high-end bed and breakfasts for a business relief claim to be successful. This has proved to be an incredibly high bar for owners to cross.
HMRC had won a number of tax cases on the basis that the nature of the services being provided by the taxpayer were insufficient for their furnished holiday lets to qualify as business property for IHT. The investment services (i.e. letting-out and property management) were found to be more significant than the non-investment services being offered by the owners. It is necessary to look at the whole business in the round, taking account of additional services provided to determine whether it would potentially qualify for business relief.
The Tax Tribunal in the 2018 case of Executors of Graham v HMRC, however, found in favour of the taxpayer. The nature and extent of the additional services being provided were such that the furnished holiday let business was ‘mainly’ non-investment. The case involved self-catering cottages on the Scilly Isles. The services provided included: swimming pool with sauna, BBQ area, croquet lawn, bicycles for hire, welcome pack and basic supplies provided to holidaymakers and taxi-service provided by owner. It took around 200 hours per week in the high season to run the business and the first-tier tribunal made reference to the level of personal care provided by the owner when reaching their decision.
The Graham case does however seem to be the exception with the Tax Tribunal once more finding in HMRC’s favour in the 2020 Scottish case of Cox (Executors) v HMRC. In this case HMRC held that even though the furnished holiday letting business was run to a high standard, there was nothing exceptional about it to compare with the business considered in Graham.
Furnished holiday let owners should be reviewing their business to see if there are any simple, practical and financially viable steps that can be taken to increase its commercial standing and to maximise the nature and extent of additional services being provided to holidaymakers.
Additional services that may strengthen a future business relief claim could include: welcome packs and catering, providing telephone and television, housekeeping services, booking and arranging excursions and other activities such as a swimming pool, cycling and horse-riding.
Buying a holiday home can involve extra tax charges.
It will be important to consider the LBTT (Scottish property) or SDLT (property in England and Northern Ireland) implications on purchase. A supplementary LBTT/SDLT additional dwelling supplement (ADS) now applies on the acquisition of additional residential properties on purchase with a value over £40,000 taking place on or after 1 April 2016. Homeowners looking at buying a furnished holiday let may be caught by this supplementary charge.
This ADS charge is levied in addition to the normal rates of LBTT/SDLT applied to the purchase price of the property. The LBTT ADS charge was increased from 4% to 6% from 16 December 2022. The SDLT ADS charge remains at 3%. There would, for example, be an additional £18,000 LBTT charge on the purchase of a Scottish buy-to-let property for £300,000 where you already own your family home.
A 2% SDLT surcharge is also now charged where non-UK residents purchase residential property in England and Northern Ireland with effect from 1 April 2021.
Holiday homeowners should adopt a proactive approach to preserve the favourable tax status available for furnished holiday lets while at the same time offering an attractive commercial proposition.
It’s always important to consider the tax implications on the acquisition, ownership and disposal of any interest in property. Simple and effective advice given at the earliest opportunity can help ensure you minimise your tax exposure and protect your interests while maximising the benefits of property ownership.
Anderson Strathern has a large number of tax and property specialists who are able to provide you with practical, commercial and tax-effective solutions to guide you through the property tax maze.
Note: this article was originally published in April 2021 and updated in September 2023.
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