Case Study – Costs Of Dealing With Problem Tenants

Lee Sharpe l looks at dealing with problem tenants from the landlord’s perspective.

Fundamentals 

1. Legal costs

These are not always allowable. They may relate to the acquisition or disposal of property, in which case they are a capital cost and deductible only for capital gains tax (CGT) purposes when that property is sold. Strictly, every new lease is a capital cost and not allowable, although renewals of ‘short’ leases (of less than 50 years’ duration) are normally allowable. 

However, HMRC’s Property Income manual (at PIM2205) advises that: ‘Where a replacement lease follows closely on a previous one, and is in broadly similar terms, a change of tenant will not normally make the associated legal and professional costs disallowable’ (emphasis added). In effect, a replacement lease on similar terms is treated as if it were a renewal of an existing lease. PIM2205 also confirms that the cost of evicting an unsatisfactory tenant in order to re-let the property is also tax-deductible.

2. Repairs to a property

Repairs to make good damage caused by a tenant are an allowable expense. This holds good whether the damage amounts to normal ‘wear and tear’ or something far worse. Basically, whatever is required to bring a property back to the standard it was in when it was first let is an allowable repair. It is only when works improve the property to a higher standard (such as extensions, or using higher-quality fixtures) that relief is denied, to be claimed for CGT only when the property is sold – provided the improvement is still there, of course.

3. Expenditure incurred while a property is empty 

This is still allowable, provided the landlord still wants to let the property. 

Case Study: Problem Tenants

Sanjay has a single property, which he has let for several years. His previous tenants have left after a couple of years, and he takes the opportunity to re-decorate the property, and to replace the kitchen on a like-for-like basis. He then takes on the Simpson family as tenants. They provide a £500 deposit, and all is well. 

Within a few weeks, however, neighbours report to Sanjay that the Simpsons – and particularly the son, Bart – are becoming a nuisance. The house is noisy late into the night, with frequent visitors and parties. Bart has apparently turned the front garden into a skateboard park. Sanjay is horrified when the letting agent’s scheduled visit reveals the following:

• The property’s front lawn has in fact been dug up and converted into a rudimentary skate-park; the rear garden has been turned into a giant mud-pen for the family’s pet pig. It would cost £1,500 to clear, re-turf and to re-bed both front and rear gardens.

• The walls in the front bedroom (presumably Bart’s) have been damaged, with the wallpaper and even the underlying plasterwork in some areas needing replacement. Based on the markings on the wall, someone has been playing football inside the house, probably because there’s no room in the garden any more. It will cost £500 to re-plaster the room and replace the wallpaper.

• The newly-fitted kitchen has been badly damaged, with scratched surfaces, missing doors and the integrated microwave is missing. The kitchen would cost £5,000 to re-instate, including the integrated appliances.

Needless to say, Sanjay is not amused. He has insurance which will cover the structural damage to the property, but the insurers will not cover the lawns, arguing ‘aesthetics’. There is an excess on the insurance policy of £500. Sanjay instructs his solicitors to set about evicting the Simpsons as unsatisfactory tenants. He realises that this will be expensive but he sees no other course of action – the neighbours are complaining that the skate-park is turning into a major attraction for kids from all over the area, and Bart has apparently started charging an entrance fee!

Surprisingly, Sanjay’s solicitors are delighted, since the tenancy agreement explicitly forbids any unapproved commercial activity at the property, and immediately commence proceedings. 

After several more months and thousands of pounds in legal fees, Sanjay finally recovers possession of his property. The house is in a parlous state, and will need re-decorating throughout. The bathroom will now also need replacing. The boiler and most of the copper piping in the property have disappeared. Thankfully, the electrical wiring seems still to be sound, once the arc lights overlooking the front garden/skate-park have been removed. Given that the plasterwork in other rooms is also showing signs of wear and tear, Sanjay decides to pay for the entire house to be re-plastered. 

Schedule of Costs and Works

Detail	Cost	Met by Insurance	Cost to Sanjay	Tax-Allowable against Rental Profits
Legal costs of eviction	£5,000	£0	£5,000	£5,000
Legal costs of replacement lease on similar terms to new family, the Griffins	£500	£0	£500	£500
Replace boiler and parts of central heating system	£2,000	£2,000	£0	N/A – no cost to taxpayer
Re-plaster throughout	£6,000	£500 for Bart’s room only - the rest is not covered as no evidence of further damage	£5,500	£5,500 – would normally be allowed as part of the routine maintenance cycle of property in any event.
Re-decorate	£4,000	£1,500 for kitchen, bathroom and bedroom – rest is due to re-plastering	£2,500	£2,500 allowed on same basis as re-plastering
New kitchen and bathroom	£7,500	£7,500	£0	N/A
Repairs to electrics	£250	£250	£0	N/A
Re-instate gardens	£1,500	£0	£1,500	£1,500
Electricity bill – tenants’ liability but unpaid by them	£750 (arc lights are expensive!)	£0	£750	£750 – a direct cost of letting the property
Ongoing costs in the void period: ·         Council tax ·         Electricity ·         Water ·         Mortgage interest*	£3,000	£0	£3,000	£3,000 – direct cost of letting the property / putting it back into a fit state to re-let
Insurance Excess		(£500)	£500	£500 – allowable repair costs not covered by insurance
Deposit recovered			(£500)	(£500) – recognised when Sanjay knows that the funds will be appropriated to cover his costs (see PIM1051)
TOTALS	£30,500	£11,250	£18,750	£18,750

If Sanjay were to fundamentally revise his tenancy agreement, then there is a risk that it would not be considered a ‘replacement lease on broadly similar terms’ in line with the guidance at PIM2205, in which it case it might not be deductible against rental profits. 

If Sanjay were to decide to improve the kitchen by making it more ‘tenant-proof’ then it could potentially be disallowed against rental profits as an improvement. 

If Sanjay were to decide not to let his property, then his ongoing costs from that point onwards (mortgage interest, heat and light, etc) would not be deductible, as the costs would not be incurred wholly and exclusively for the purpose of his letting business. Note, however, that costs incurred during the re-instatement process, such as heating to dry out plasterwork, should still be allowed. 

There may be some comfort to Sanjay in that most, if not all, of his net costs to put the property back into good order should be allowed against his rental profits. Of course, insurance proceeds will reduce Sanjay’s net cost, and so his tax-allowable costs – as will any tenant deposit appropriated to cover reparations, etc. 

Where Sanjay has the option to improve things (‘tenant-proofing’, etc.) so as to prevent such costs in future, he will need to weigh up the possible cost of losing tax relief against the potential savings in future costs if future tenants turn out to be as bad.