Sarah Bradford explains how capital expenditure is relieved where landlords prepare accounts using the cash basis.
The cash basis is a simplified basis of assessment that allows landlords to compute profits by reference to money in and money out, removing the need to match income and expenditure to the period to which it relates, as is necessary under the traditional accruals basis.
Under the cash basis, income is recognised when received and expenses are recognised when paid – there is no need to take account of debtors and creditors, or of prepayments and accruals. A further advantage is that as income is only taken into account when received, relief for bad debts is given automatically.
When does the cash basis apply?
The landlord must use the cash basis to work out taxable profits if none of the following conditions is met.
Condition A
Condition A is met if the business is carried on at any time in the tax year by:
- a company;
- a limited liability partnership;
- a corporate firm;
- the trustees of a trust; or
- the personal representatives of a person.
A partnership is treated as a `corporate firm’ if a partner in the firm is not an individual.
Condition B
Condition B is met if the cash basis receipts for the year exceed £150,000.
The cash basis receipts are those that are taken into account in working out the profits of the property business on a cash basis.
Condition C
Condition C is met where property is owned jointly with another person who cannot use the cash basis to prepare accounts (for example, where their receipts exceed the cash basis entry threshold of £150,000).
This situation will commonly arise where a property is owned jointly by spouse or civil partners and the spouse or civil partner computes profits using the accruals basis.
Condition D
Condition D is that:
• a business premises renovation allowance is made at any time in calculating the profits of the property business; and
• if the profits of the business for the tax year were calculated in using the accruals basis, a balancing adjustment would arise for that year.
Condition E
Condition E is that the landlord elected for the accruals basis to apply in calculating the profits for the property business for the tax year in question.
This is only relevant if conditions A-D are not met; if any of these conditions are met, the cash basis does not apply, and consequently the need to make an election is not in point.
Capital expenditure rules
The rules governing relief for capital expenditure under the cash basis as it applies to traders were reformed from 6 April 2017. The rules also apply to landlords who use the cash basis to work out their taxable profits.
Under the cash basis, capital expenditure is simply deducted (as for an expense) in working out taxable profits unless the capital expenditure is of a type for which relief by deduction is specifically disallowed.
This applies to capital expenditure that is incurred in, or in connection with, the provision, alteration or disposal of land. However, this restriction does not prohibit a deduction being made in respect of expenditure on an asset which is installed or otherwise fixed to qualifying land so as to become part of the land, unless the asset is one of the following (in which case the expenditure is not deductible):
- a building;
- a wall, floor, ceiling, door, gate, shutter or window or stairs;
- a waste disposal system;
- a sewerage or drainage system;
- a shaft or other structure in which a lift, hoist, escalator or moving walkway may be installed.
Under the cash basis rules, a deduction is also specifically disallowed for expenditure on an item of a capital nature which is incurred on, or in connection with, the provision, alteration of disposal of an asset for use in an ordinary rental property. This is subject to the relief for replacement domestic items (which applies under the cash basis as under the accruals basis) and provides for a deduction of domestic items where the replacement is on a like-for-like basis.
An ordinary residential property is a residential property in relation to which an ordinary property business is carried on (but which excludes furnished holiday lettings).
The cash basis rules also prohibit a deduction for expenditure on an item of a capital nature incurred on, or in connection with, the provision, alteration or disposal of:
- any asset that is not a depreciating asset;
- any asset that is not acquired or created for use on a continuing basis in the property business;
- a car;
- a non-qualifying intangible asset;
- a financial asset.
Depreciating assets are those where, on the date on which the expenditure is incurred, it is reasonable to expect that within 20 years of that date the useful life of the asset will end, or its value will decline by 90% or more. The useful life ends when the asset can no longer be of use to any person as an asset of a business.
Intangible assets include internally-generated intangible assets and intellectual property. A non-qualifying intangible asset is, broadly, one that will cease to exist in 20 years.
A financial asset is any right under or connection with a financial instrument or an arrangement that is capable of producing a return that is economically equivalent to a return produced under any financial instrument.
As relief for capital expenses is given by deduction, capital allowances are not available. The exception is for cars. However, capital allowances are not available for cars if a deduction for vehicle costs is claimed using simplified expenses.
Example: Cash basis landlord
Jonny is an unincorporated landlord who meets the cash basis conditions. As he has not made an election to prepare accounts under the accruals basis, the cash basis applies by default. He has a number of properties which he lets out.
In 2018/19, Jonny purchased van for £10,000 which he uses exclusively for his property business. Keen to expand his property portfolio, he purchases a further property for £200,000. He also purchases furniture and white goods for the property, which he lets out as a furnished let.
Under the cash basis capital expenditure rules he can claim a deduction for the cost of the van when computing the taxable profits of his property rental business.
However, he is not able to claim a deduction for the cost of the new property or for the cost of the furniture, relief for which is prohibited under the replacement of domestic items rules (although, relief is available under those rules if and when the items are replaced).
What about capital receipts?
As a deduction may be given for capital expenditure in computing profits under the cash basis, disposal proceeds are treated as a receipt if the disposal receipt is received in a year where the cash basis was used, and the associated expenditure was deductible (or would have been had the cash basis been used in the year in which the expenditure was incurred).
Practical Tip:
Where the cash basis is used, remember to deduct all items of capital expenditure for which a deduction is not prohibited in calculating the taxable profits. Good records should be kept so items of capital expenditure are not overlooked.
