Given the current low-interest rates and mortgage rates, many people believe it is more beneficial to invest in property. A buy-to-let investor will buy the property to rent it out and earn more return on investment than keeping the money in a bank. However, these interest rates might increase in the future. Moreover, if the mortgage rates rise, the initial deposit will remain the same, meaning the investor suffers a loss. Also, a new law in the UK states to pay a 3% stamp tax on all new purchases.
Furthermore, the current interest and mortgage rates make it suitable for people to invest in property. This is exactly what buy-to-let investors have been doing for a while now. However, the Buy-to-let market has incurred significant changes. There has been an increase in tax on capital gains as well as the restriction of tax relief on interest paid to the basic tax rate.
How to counter this
Consequently, one should be extremely mindful about where to invest the money so they can cover the rising costs and taxes as well as make a profit out of it. As much as it has become difficult earning from a buy-to-let investment, investors shouldn’t be discouraged. There are better options out there, such as investing in furnished.
What is the major difference?
There is no doubt that the investment demand for Furnished Holiday letting is on an exponential rise as seen by the popularity among investors. It is due to some appealing factors of this class of property that is that it offers a tax relief which other buy-to-let properties don’t– most commonly on pension contributions. Some people usually confuse this class of property with the more common and traditional buy-to-let class of property and wonder as to why this class has the advantage of tax reliefs and higher returns.
The major disparity among the two is the classification the two investments are subjected to by the Government. Buy-to-let properties are classed as investment income, whereas FHLs is regarded as a trading activity. Similar to the care home investments, holiday homes earn the remunerations of both residential and commercial properties.
Now I’m sure many questions originate in your mind when you hear the name Furnished Holiday lettings. Let’s have a look at what it is, how it works, what are the procedures to follow, the tax situation, and the advantages.
Answering the WHAT
First and foremost, A Furnished Holiday Let, commonly known as FHL, is a specific type of rental property in the UK, Ireland and other European countries. This classification of the property offers a better tax package to Holiday let owners. It is due to these tax advantages that Buy-to-let investors should consider furnished holiday lettings. However, there are certain conditions that must be met in order for a property to be classed as FHL. These conditions include the availability, location, the level of furnishing, commercial motive, and actual bookings.
Let’s dig a bit more into these conditions
If the property is situated in the UK or the EU and other places such as Liechtenstein, Iceland, and Norway, it is eligible to qualify as FHL, but the following conditions must be met.
So first of all, there needs to be sufficient furniture available for visitors to use, and the level of furnishing should be enough for the visitors to be able to make use of it. As much as obvious it may sound, it is still a part of the whole requirement process.
There are no hard and fast rules as to what qualifies as furnished, but you should keep in mind what furnished holiday accommodation must provide to its visitors. So as long as you have the basics, you will be good to go. An important thing to keep in mind is that some of the expenses related to furnishing might fall under Capital gains tax relief. If you are still unsure about this, then you can consult an experienced holiday letting agency.
The profit motives
Moreover, the basis of the business should be on a profit-making motive. This means that it should be commercialized. Furnished House lettings when closed usually don’t make any profits, but they make enough to cover the maintenance costs so the letting can still be regarded as commercial. Also, you should be aware that letting to your family and friends at no or less cost isn’t commercial.
Now If your property fulfils these conditions, then you can have a look at the more challenging ones.
It is a requirement that the relevant property needs to be available for commercial letting for at least 210 days in the relevant period to the public as holiday accommodation. Not meeting this condition will make the property non-eligible for the tax year, depriving you of the tax advantages.
For this condition, it is required that the property is let commercially for at least 105 days, as furnished holiday accommodation to the members of the public. An important thing to keep in mind is that commercially letting to the same person for more than 31 continuous days is not considered as letting. Not meeting this condition will also deprive the property of the Furnished Holiday lettings tax advantages as it won’t be considered for the tax year.
The pattern of occupation
This condition is simple yet complex. If you have let the property for continuously for more than 31 days and this adds up to 155 days in total throughout the year, then the property will not be considered as Furnished Holiday letting in the given tax year, again depriving you of the tax advantages.
Once your property has met all these conditions, it will be considered as a Furnished Holiday Letting, and you can claim all the tax benefits of this class of property. However, while all the challenging conditions seem a bit tricky, there is some relief in them too.
The averaging elections
For example, if your property fails to meet the required occupation figures, then an average of all FHL properties can be taken. As long as on average each property is let for at least 105 days in the tax year the condition is considered to be fulfilled. This is in the case where a person has more than one property let as furnished holiday accommodation at the same time. Let’s take a look at an example. Suppose a person has four properties which in total were let on lets of less than 31 days for at least 420 days. This means the letting conditions are met under an averaging election, even if any individual property is let for less than 105 days.
The averaging election is required to be made by 31st January following the end of the tax year.
The two consecutive years of Grace
Moreover, once you are out of the probationary period after meeting the occupation figures requirement, you will receive a grace period relief for two consecutive years. This means that the status of FHL can be maintained as long as you meet your occupation requirements going forwards.
This can be achieved by showing that there was an honest intention of letting the property, but due to some unforeseen circumstances, it couldn’t happen. It is essential to have met the letting condition in the foregoing year of the year for which you are making the first period of grace election. More so, the second period of grace election is also allowed. However, the property won’t qualify as a Furnished Holiday Letting if it does not meet the letting conditions in the fourth year post the two connective grace elections.
The Tax break down and benefits as a result
Furnished Holiday Lettings have beneficial tax-deductible expenses. This means that you can have a claim of the capital grants on the Furnished Holiday letting property. This allows you to cut down on the cost of turning your property into a luxury furnished Holiday lettings. As a result, your potential income automatically increases because the expenses of turning it into a luxury standard can be deducted from your pre-tax profits. However, this option isn’t available for properties based on long term rental motives.
Another important advantage is that you can make tax-advantaged contributions to the pension. This is because the income generated from a Furnished holiday letting property falls under the category of ‘relevant earnings’ allowing you to make tax-advantaged contributions to your pension.
Selling an FHL property
Selling a furnished holiday letting makes you eligible to claim relief on certain tax gains. However, these do not apply to properties that are in business for long term rental. The reliefs included are roll-over relief, entrepreneur’s relief, and holdover relief.
The ease of splitting the profit between Husband and Wife
If the FHL property is jointly owned by you and your spouse, it offers the flexibility to distribute the profits between both due to tax purposes. However, if the property is in a long-term rental business, the profits are distributed according to the official ownership divide. For example, if a person owns 50% of the whole property, then he/she will be eligible to claim 50% of the entire profits. This class of property offers you the flexibility to divide the profit; however, you like.
The Council Tax relief
If your furnished holiday letting is available for accommodation to the public on a short-term basis for over 140 days in any given year, then it is to the business rate property tax. Given the condition for a property to be FHL has to be let for at least 210 days throughout the year automatically makes it eligible for business rate tax. However, there is a relief to this because a small business rate relief of up to 100% can be claimed and you can throw council tax out of your worries.
The potential disadvantages that you may face
The major disadvantage related to FHL property is VAT. In case the turnover from your FHL class property crosses the VAT limit, you would have to register for VAT. However, this is not as big of a problem because to be eligible for VAT registration; you need to exceed the £1,500 limit. So, for just one FHL property, to exceed the limit, it will be required to let the property for 52 continuous bookings. So, it should not be a source of worry if you own an individual FHL property. However, you are more likely to be required to register for VAT if you have multiple FHL properties. Additionally, running a separate business alongside an FHL property will also put you under the VAT threat.
Another disadvantage that Furnished holiday lettings can incur is that losses cannot be offset against other taxable income. You cannot offset losses from a furnished holiday letting against other income. These losses would have to be offset against future profits and therefore put you at a disadvantage. The losses, moreover, have a snowball effect as they can add up across multiple years.
The allowable expenses of a Furnished Holiday Letting
Furnished Holiday Lettings are treated no differently than normal businesses when it comes to expenses. Due to this, you are allowed to offset the expenses against the revenue. In addition to this, the two important things to keep in mind are that the claimed expenses must be against commercial use specifically. You cannot claim the expenses if the property is being used by family, friends, or even yourself. So, you would have to keep a record of what part of the expense is commercialized and what part is privatized. For example, if the property is used for private purposes for four months of the year, then the commercial expenses will be 66.66%.
Moreover, capital expenses do not fall under allowable expenses for FHL properties. For example, the expenses that are one-off such as construction or repair. These can be claimed under the capital allowance. Some examples of allowable expenses include interest on the loan associated with the property, utility bills, advertising and marketing fees, maintenance and cleaning costs and products that are bought specifically for the property.
The bottom Line
Keeping in view the deteriorating health of the buy-to-let investors due to changes made by the Government turning towards Furnished Holiday Lettings is a suitable option. With the commendable tax advantage over regular buy-to-let properties, it is a win-win situation for the investor. All the conditions to qualify to be an FHL are not a big hurdle. If you are determined to achieve FHL status for your property, then it is a piece of cake. The tremendous tax reliefs and rate on investment hold robust convincing powers to make you go for it. Moreover, FHL class properties are gaining popularity by the day, and tourism is already on an exponential rise so you shouldn’t miss out a chance.
However, getting the financial books ready for this is still a hassle. It is not easy to make yourself qualify for the conditions without having a good grip over your accounts and finances. Moreover, with the frequent changes in tax policies, it has become essential to always keep a track. For this, hiring an accountant is extremely helpful. The accountant can help you prepare to give your property a Furnished Holiday Letting status sooner than you expect. Pearl accountants have started offering their service for Furnished Holiday Lettings and their brief about it is quite convincing. Have a look(landing page link here) at it yourself and see if their services are the ones you are looking for.
Shoaib Aslam is the co-founder of Pearl Chartered Accountants, a UK-based chartered accountancy firm that has multiple locations across London. They are experts in helping startups and established businesses with all aspects of growth, strategy, scaling up, accounting and tax planning.