This article considers the taxation of houses in multiple occupation (HMOs) and those issues that apply particularly to HMOs.
A typical example of an HMO would be student-type bedsit accommodation in a larger former single-household dwelling that has been modified to cater for several unconnected tenants, to provide private bedrooms, but with larger communal facilities, such as kitchen, lounge, etc.
The rate of return for an HMO can significantly exceed that which might typically be enjoyed for a single-dwelling use of that property, broadly by maximising the efficient use of the space and facilities available.
It’s complicated!
There can be many permutations in the above broad description of an HMO, but:
• A self-contained flat or apartment, holding all the facilities required for private domestic existence, is not an HMO or part of an HMO.
• HMOs have communal areas or shared facilities – facilities that are necessary for day-to-day private living. So, a communal sauna does not of itself turn a block of otherwise self-contained flats into an HMO (unless perhaps you’re Finnish!).
Now that we think we know what an HMO is (or maybe just what it is not), and that they can be attractive in terms of potential yield, it is important also to recognise that there can be complications with HMOs:
• HMOs are specialised and re-sale value may suffer as they will not have mainstream appeal (although a property could – at further cost – be converted back to a single-household dwelling, prior to sale).
• There can be more demanding regulatory requirements, depending in some cases on the local housing authority that is responsible for the property.
• Up-front costs to convert a normal single-household dwelling into an HMO will generally be higher, and may well include a relatively larger proportion of capital expenditure that will be allowed only against CGT when the property is disposed of.
Learn from others’ mistakes
Many readers will be aware that it is possible to claim capital allowances on qualifying capital expenditure – including the 100% immediate annual investment allowance (AIA) – in commercial premises, but not in typical residential lettings.
It is not uncommon to achieve 100% tax write-down on around 10% (or more) of the initial capital outlay on a commercial property. Not only does this have the potential to significantly reduce a property business’ taxable profits, but if it goes so far as to result in a net property business loss, the capital allowances element can then be claimed against other income of that year, and the following tax year, which can be very useful for people with multiple income sources (ITA 2007 s 120, et seq).
Having said that, residential lettings are generally unable to claim capital allowances (save for hotels, B&Bs, furnished holiday accommodation, and similar), but it is possible to claim capital allowances for certain qualifying expenditure in HMOs – excluding the ‘dwelling areas’.
The Tevfik case
The case Tevfik v HMRC [2019] UKFTT 600 was heard in September 2018 but not reported until later in 2019. The taxpayer lost the case, and some commentators have – wrongly – said that this case proves that capital allowances are not available in HMOs.
This may be what HMRC originally said when denying the taxpayer’s capital allowances claim, but it is not what the judge found when considering the case. The taxpayer lost because he tried to claim 100% AIA on expenditure incurred before AIAs were available in law and because he did not then modify his claim, even when he was given an opportunity to do so.
Common areas vs communal areas
Since HMRC’s Business Brief 45/10, which is now almost a decade old, HMRC’s position has been that the dwelling part of an HMO includes the communal areas, such as kitchens and lounge areas available to tenants, as well as their private bedrooms. Before then, HMRC had for a time allowed capital allowances claims on relevant expenditure on the shared facilities such as communal kitchens, lounges, bathrooms, etc.
In Tevfik, the judge recorded, ‘HMRC say that in an HMO, it is the totality of the property that forms the dwelling-house. It is the house as a whole that provides the facilities for day-to-day private domestic existence and hence the house as a whole that is the dwelling-house’. Since capital allowances cannot be claimed within a dwelling-house, HMRC was essentially seeking to deny capital allowances anywhere in an HMO building.
While he ultimately found against the taxpayer for other reasons, the judge disagreed with HMRC’s position, saying:
‘[While] a communal kitchen and lounge are also part of a dwelling-house… [t]he ‘common parts’ of the building such as the common entrance lobby, corridors, stairs or lifts and those parts of the building which do not provide any living facilities would not, however, comprise a ‘dwelling-house’. Neither are installations to the building such as mains, gas or electrical services, nor security and communication systems’ (emphasis added).
In essence, the taxpayer’s claim failed because he did not identify the expenditure incurred specifically in relation to the common areas, as distinct from the communal areas. A similar approach may be applied to a block of self-contained flats, in relation to parts of the building beyond the flats themselves.
Communal areas are living spaces shared by the tenants, such as kitchens and lounges; common areas are those that form part of the building but are not living spaces (entrance halls, stairways and landings, cellars, roofspace, etc.)
Stamp duty land tax, etc.
HMRC’s stated position in relation to student accommodation can potentially be helpful because, for example, it may allow a landlord to claim multiple dwellings relief (MDR) on a single HMO building on a much lower average price, as per the Stamp Duty Land Tax manual at SDLTM29957:
‘For the purposes of multiple dwellings relief at FA 2003 Sch 6B, where student accommodation is treated as used or suitable for use as a dwelling, the extent of a single dwelling will be determined on normal principles. For example, in the case of a block of flats available only to students, each of which consists of individual study bedrooms with communal kitchen and bathroom facilities, each flat within the block will be treated as used, or suitable for use, as a single dwelling’ (emphasis added).
Note that the equivalent Scottish Land and Building Transaction Tax, and now the Welsh Land Transaction Tax, each have their own versions of MDR, but the detailed rules will not necessarily be the same.
VAT
Here again, the VAT rules generally take a quite generous approach towards HMOs. VAT Notice 708 Buildings and Construction confirms (at section 7) that construction services may be charged at only a reduced rate of 5% (instead of the standard 20%) when converting premises to a multiple occupancy dwelling, which is similar to the treatment when changing the number of single-household dwellings within a particular building envelope:
‘If you carry out work to an existing building you will normally have to charge VAT at the standard rate [20%]. You may be able to charge VAT at the reduced rate of 5% if you’re converting premises into a… ‘multiple occupancy dwelling’, such as bedsits.’
Note, however, that converting a multiple occupancy dwelling into another multiple occupancy dwelling does not work; (see the table at section 7.2 of the VAT Notice); care is also needed if the conversion is to suit a ‘relevant residential purpose’ such as student accommodation, although this can sometimes be a gateway to 0% zero-rating instead.
Conclusion
Note that capital allowances cannot generally be claimed (other than for cars) when the new cash basis for landlords is in point (property businesses within scope have to elect out every tax return year, but it may well be to one’s advantage to do so).
Note also that HMOs tend to be larger and more expensive properties, so may well be exposed to the annual tax on enveloped dwellings (relief from ATED is available if the property is part of a letting business, but you must claim every year).
HMOs and their conversion can be an expensive prospect, and any opportunity to reduce the SDLT, VAT and/or even income tax cost should be welcomed – but please do make sure to consult on the finer detail beforehand, as these are complex aspects of already-complicated areas of tax law.
