Spending Money on Property repairs to offset the impact of ‘section 24’ mortgage interest relief restrictionsFirst Published: Nov 2018 | Available in: Property Articles Your Property Network
The single biggest tax issue facing many landlords who own mortgaged residential rental property is the introduction of the new (as of tax year 2018) mortgage interest relief restrictions known as ‘Section 24’. This article looks how landlords can spend money on property repairs to help to mitigate the impact of this significant worsening of the tax regime for ‘private landlords’ (meaning, landlords who own their property in their own personal name, or in a partnership).
Section 24 – a quick recap
The ‘Section 24’ mortgage interest restrictions means that between tax years 2018 – 2021, claiming mortgage interest as an expense will be progressively phased out, & instead replaced with a ‘tax credit’ at a fixed rate of 20%, regardless of the tax rate of the individual. The impact of this in many cases can ‘convert’ a Basic Rate (20%) taxpayer into a Higher Rate taxpayer, without any change to the underlying property rental profits, which can create very high marginal tax rates (download pdf article to view calculation table).
OK, so how can spending money on repairs help from a tax & Section 24 view?
Property repairs are, of course, a legitimate business expense for a landlord, & so will reduce taxable profits on a £ for £ basis. So, now more than ever there is a significant tax benefit in spending money on repairs which maintain & improve the value of a rental property.
For a Basic Rate taxpayer in the example above, the tax benefit of a £10k refurb BEFORE Section 24 was £2k (20%), however with Section 24 fully in force the tax benefit of the same £10k refurb DOUBLES to £4k (40%).
OK, that sounds like a good deal – but aren’t I in business to make money – if I spend all my profits on repairs how does that make overall sense?
Fundamentally, of course, repairs have to be necessary & value for money in order to make overall business sense (so, no gold taps & marble bathrooms just to get a tax benefit!).
But, sensible money spent on maintaining a rental property to the right standard to attract & retain good tenants is usually money well-spent – & translates into better rent levels & occupancy.
Spending money on repairs isn’t a case of ‘all or nothing’ – in the example above just £10k of extra repairs would have completely eliminated the impact of Section 24, & so there wasn’t a need to go further than that (from a tax-planning view) once the Higher Rate tax exposure had been eliminated.
Example of routine regular repairs & renewals that almost all properties require are:
- Replacement kitchens & bathrooms
- Decoration & replacement carpets
- Upgrade of single-glazing windows to double-glazing
- Upgrade of electrics & plumbing to ‘modern day standards’
Less regular, but nonetheless important repairs & renewals include:
- External pointing & brickwork to improve kerb appeal & ensure a watertight property
- Replacing boiler & water tanks
- Internal plastering & skimming
- Replace Damp Proof Course & external flashings, repair chimneys & flues etc
- Roof tile / felt / battens repairs & replacements
What is a ‘repair’ for tax purposes?
Most day-to-day maintenance works are simple repairs & replacements of assets within a property. These costs are therefore treated as ‘revenue’ costs, as they are deducted from revenue (income) to arrive at a rental profit – the following provides further guidance:
1. Pre-first-let refurbs
Often, residential landlords will complete a refurb before the first tenant moves into a property. The mere fact that repairs are undertaken not long after the property is acquired does not, in itself, make the cost capital. However, the most likely timing of any capital works is before first let, so it is essential to ensure costs are claimable as revenue by carefully detailing all works & allocating between capital / revenue.
2. ‘Modern equivalents’ refurbs
Sometimes it is uneconomic to repair an asset, or, modernisation is better. Examples include replacing single glazing with double glazing windows, or iron guttering with modern plastic. Where such ‘modern equivalent’ replacements are used, even if there is some improvement, the costs are treated as revenue. The ‘improvement’ element would need to be substantial, for the costs to be treated as capital – for example, replacing an old conservatory with a new brick-built extension.
In my experience of dealing with hundreds of landlords, its rare for general works to be treated as capital, & where that is the case, it is usually beyond any doubt. Again, this is an area where many investors are too cautious in their view of capital vs revenue – seek professional advice as often the sums involved are significant.
3. How to prove your repairs are revenue
If mortgaged, the property will have been surveyed by the lender. On the survey report, the surveyor will have indicated if the property was currently lettable. If ‘yes’, this is good evidence that costs incurred after purchase but before first let were general repairs & so revenue costs.
If a retention is placed on the mortgage offer, again, this provides good evidence as to the proportion of the works that is capital vs revenue. Surveyors often state that ‘floorings, kitchen & electrical fittings need updating’ – so, in the event of a £3k retention (say), we might only need to treat £3k of the refurb costs as capital.
Other useful proof is video or photographic evidence – to show that the property was fit for let before works. If the property was bought already-let, again this is good evidence of condition.
Finally, be sure to have tradesmen describe the works carefully on their invoices. HMRC will only ever conduct a ‘desktop’ check of the tax treatment of costs – they won’t visit your property – so we need to make it easy for an Inspector to agree with us – evidence helps to do this.
4. ‘Incidental’ improvement
Often, there is a small degree of ‘incidental’ improvement when completing a refurb, which strictly should be split out & treated as capital. However, by HMRC concession, such works are treated as fully revenue spend, where the capital element is modest & incidental.
5. Repair provisions
A ‘provision’ allows an investor to include the cost of refurb works into their accounts & tax return for the year, even if the work has not yet been completed, or, if it has been completed but the invoice has not been received or paid by year-end. To do this, the investor must have actually incurred the liability – for example, the works have been ordered by the freeholder, or the works have been done but are not yet invoiced.
Timing of extra repairs – phasing of Section 24
Spending more on property repairs & maintenance makes tax sense for landlords who are Higher Rate taxpayers, given HMRC are effectively paying 40% of the cost via tax relief. But, bear in mind that Section 24 phases in over 4 tax years (2018, 2019, 2020, 2021), with 25% / 50% / 75% / 100% of finance costs in those years being replaced by a flat-rate 20% tax credit.
So, there is some tax sense in spreading additional (non-emergency) repairs into future years, to ensure a Higher Rate (40%) tax benefit, rather than embarking on a single-year very significant repairs programme which may mean that some of the spend in only tax-deductible at the Basic Rate (20%) rather than the Higher Rate (40%) of income tax.
And, there is some sense in waiting until December / January each tax year
Balancing tax-planning with other considerations
Spending more on property repairs & maintenance makes tax sense for landlords who are Higher Rate taxpayers, given HMRC are effectively paying 40% of the cost via tax relief.
However, as mentioned earlier, it is only beneficial to make necessary & value-for-money repairs, even with the tax benefit – for my own portfolio, there is always a property that could do with a new boiler/kitchen/bathroom/some tiling or flooring/ external works/ decorating etc – I would be surprised if the average portfolio landlord ever runs out of repairs to pay for.
Also, it’s tempting as a landlord to only ever spend money on repairs between tenancies, but keeping repairs ticking over can make for happy tenants, & avoid the void in the first place.
Often tenants will also chip with labour & pay towards mid-tenancy repairs, which can keep tenant satisfaction high & maintain rent & occupancy levels (don’t forget the fundamentals of renting property haven’t changed with the introductions of Section 24 – this is a ‘fixed cost’ business where the big costs are largely fixed and income rate & occupancy levels determine overall profits – like hotels and airlines for example).
In summary …
Spending money on necessary and value for money repairs can mitigate the impact of Section 24 mortgage interest relief for ‘private landlords’ (i.e. those not operating via a company) who are ‘pushed’ into being Higher Rate (40%) taxpayers as a result. Most landlords can see the sense in spending money on minimal repairs, but there is also now a substantial tax benefit in many cases in spending more on water-proofing, weather-proofing, kerb-appeal improvements, as well as the more usual kitchens / bathrooms / decoration. And, keeping paying tenants happy with sensible and business-savyy repairs that HMRC chips in 40% for sounds like a good way to operate a successful property rental business.