In this third instalment on tax principles for capital against revenue expenditure (the latter normally being advantageous because it is immediately deductible for tax purposes), we take things one step further and look at additional expenses that can be offset as repairs.
In the previous article we looked at repairs in the context of residential property letting, and a typical example of Jennifer, who had just acquired her first investment property and wanted to do some repairs before letting it out:
Replacement Windows £ 5,000
New Kitchen Units £ 2,500
New Carpets £ 1,500
Wiring Overhaul £ 3,000
Central Heating System £ 4,000
Re-Decoration Throughout £ 3,500
Total Cost £19,500
We have already looked at replacement windows and found that, helpfully, HM Revenue & Customs (HMRC) agreed that double-glazing is now so commonplace that it is no longer deemed a capital improvement but a ‘like-for-like’ replacement (repair), even when the old windows were only single-glazed.
We’ll now consider the rest of the example, to see how much more expenditure Jennifer can offset immediately against her rental income, as repairs.
New Kitchen Units – Replacing an Asset in its Entirety
Next on Jennifer’s list is a new kitchen, replacing all the kitchen units. There is a tax rule that replacing an asset in its entirety is capital expenditure. If a laptop screen is damaged but can be replaced then part (the screen) of the asset (the laptop) is being replaced, not the whole asset. This would be a repair but replacing the entire laptop for a new one is capital.
How does this affect Jennifer? Once again HMRC’s own manuals are very helpful – right at the bottom of the Property Income Manual Section PIM2020 (link here), it states:
“In the case of residential accommodation we accept that the ‘entirety’ will normally be the house or the block of flats that is let. So if your roof is damaged and you replace the damaged area, your expenditure is allowable.”
It goes on to say:
“For example, if a fitted kitchen is refurbished the type of work carried out might include the stripping out and replacement of base units, wall units, sink etc., re-tiling, work top replacement, repairs to floor coverings and associated re-plastering and re-wiring. Provided the kitchen is replaced with a similar standard kitchen then this is a repair and the expenditure is allowable.”
Whilst this is all good news, a couple of further points to bear in mind: as we have already seen, improvements can be a problem. If there is tangible improvement then it can turn deductible repairs into non-deductible capital improvements. So what would happen if Jennifer wanted more, or better, units?
Improvements – Quantity or Quality?
In the previous article, we briefly touched on the idea that adding an extra bedroom to a property would constitute a capital improvement, reflected in an increased value for the property. But it is important to appreciate that, in the context of a new kitchen, if further units were added then this too would be a tangible, long-lasting capital improvement.
But the good news is that it would be possible to apportion the expenditure in that scenario; if for example 10 units were acquired, 2 were new whilst the other 8 replaced existing units, then the associated costs could also be apportioned. The same section in HMRC’s manuals (PIM2020) says:
“Work commissioned on a property may include expenditure on capital works and also separate expenditure on repairs at the same time. Here the expenditure on repairs remains allowable. Expenditure may be apportioned on a reasonable basis to estimate the amount attributable to the repair element.”
However, it would not be so easy to distinguish repairs from improvements, if all of the units were of a significantly higher quality than the originals – say, solid wood replacing cheaper composite materials. In that case, it would be impossible to separate out the improvement element and effectively the whole kitchen could be capital.
There is one final saving factor: the existing kitchen units may be old and in a poor state of repair but that doesn’t make them ‘of poor quality’ – generally, any comparison between current and replacement should be on what they were like when new.
So, provided Jennifer is careful when choosing her new units, she may well be able to ensure that the costs of the new kitchen are also entirely deductible from her future rental income.
New Carpets – Capital or Repair? You Decide!
Jennifer also has a couple of carpets that need to be replaced. With a normal residential property it would be appropriate to treat their replacement as repair costs, as long as the new carpets are not tangibly superior to the originals. Here again it is basically down to Jennifer’s choice if she wants their cost to be deductible.
Wiring Overhaul – “Necessary” Doesn’t Necessarily Mean Allowable
In this example, Jennifer has to undertake this expenditure to meet safety requirements for a let property – the wiring is currently acceptable for owner-occupation. In that case, any expenditure must be an improvement even if it is essential to the letting business.
As discussed in the previous article, just because something is required for the business doesn’t mean it is deductible as a revenue expense; an IT contractor might need a laptop to do his work but it would still be a capital item. If he needed to replace an old component in his laptop, and the replacement just happened to be better than the original because the industry had ‘moved on’ since he’d bought it, then it could be a repair.
Why was the Expense Incurred?
Let’s look at a different scenario. An electrician’s assessment found that the wiring was old and in generally poor condition and he recommended it be replaced regardless of whether the property was going to be let. If there were no significant difference between the standard for a let property as against a property in normal occupation, then the cost might well be allowable as a repair.
Remember that ‘normal’ standards for electrical installations are far superior now to what they were say twenty years ago but Jennifer would consider that such improvements were inherent in using modern construction techniques, critically provided that the installation didn’t have to be to a higher standard. So in different circumstances, the expenditure might be deductible.
Central Heating System
Jennifer has decided to replace the storage heaters in the property with a brand new central heating system because it is easier and cheaper to run. This is clearly an improvement and capital in nature therefore her costs will not be deductible.
Re-Decoration Throughout
Generally, HMRC accepts that a property needs to be decorated periodically as part of its normal maintenance cycle but Jennifer just needs to bear in mind that some of the decoration work might be necessary because of the re-wiring and installing a new heating system, and apportionment can cut both ways!
It might have meant that she could add a couple of kitchen units without the entire kitchen becoming a capital improvement; here apportionment may be necessary to recognise that some of the decorating work related to the improvements.
Practical Tip
On the whole, Jennifer should be pleased (or relieved!) that with care, most of her expenditure should be deductible as repairs. It pays to research the treatment of the expense before you go ahead with the change.
In the final article, we’ll look at how it is sometimes possible to get tax relief even for capital items.
By Lee Sharpe
