Sarah Bradford explores the opportunities for enjoying tax-free income under the rent-a-room scheme.
Making tax-free income is an attractive proposition, and those looking to earn some extra money by letting a room in their home can do just that, by taking advantage of the rent-a-room scheme.
What is the rent-a-room scheme?
Under the rent-a -room scheme, it is possible to enjoy tax-free rental income of up to £7,500. The scheme is open to owner-occupiers and tenants who let furnished accommodation in their only or main home. However, those who rent their home would be advised to check their tenancy agreement to make sure that they are allowed to sub-let rooms in the property.
When can you use the rent-a-room scheme?
The rent-a-room scheme is available where:
- a furnished room is let to a lodger (rooms let unfurnished do not qualify); or
- the letting activity amounts to a trade, e.g. running a bed-and-breakfast or providing additional services, such as the provision of meals or cleaning or laundry services.
The rent -a-room scheme is not limited to the letting of a single room – it can be used where more than one room is made available, as long as the owner/tenant continues to live in the property and the accommodation which is provided is furnished accommodation.
When you can’t use the rent-a-room scheme
The rent -a-room scheme is not available where the accommodation is not provided in the main home of the person making it available – consequently, lets in holiday cottages, second homes, and buy-to-let properties do not count. And while it is not available for accommodation used as an office or for the purposes of any business, the benefit of the rent -a-room scheme is not lost if a lodger works at home in the evening, or study facilities are provided for a lodger who is a student.
How much tax relief do you get from the rent-a-room scheme?
The rent-a-room scheme effectively allows the recipient to ignore the income received from letting a furnished room (or rooms) if the gross receipts are £7,500 a year or less. Where at least one other person receives income from letting a room in the same property, the tax-free limit is halved to £3,750. The limit of £3,750 per person applies where two or more people receive letting income in relation to a property, meaning that it is possible to receive tax-free income in respect of a single property in excess of £7,500 a year.
Example: rent-a-room relief with multiple landlords
Ben, Jake, and Harry jointly own a six-bedroom property. They each occupy a room and let out the remaining three rooms (furnished). The rental income in respect of each room is £3,500 a year. They share the rental income equally. As the rental income each receives is less than their individual rent-a-room limit of £3,750, the income can be received tax-free. Thus the total tax-free income received from letting rooms in the property is £10,500 – more than the single landlord rent-a-room limit of £7,500.
How to claim rent-a-room relief
Where the gross receipts are less than £7,500 a year (or £3,750 as appropriate), the rent-a-room scheme applies automatically and the rental income is exempt – there is no need to claim the relief. This makes life easy from an administrative perspective and the landlord can simply collect the rent without having to worry about tax.
Gross receipts above the rent-a-room relief limit
It is still possible to use the rent-a-room scheme if the letting receipts are more than £7,500 (or £3,750 where two or more people receive the rent in relation to the property). However, in this situation the landlord has a choice as to how the taxable profits are calculated. The best option will depend on the level of expenses incurred by the landlord in relation to letting out the room.
Under Method A, the landlord simply works out his or her profit in the usual way by deducting expenses and capital allowances, where applicable, from rental receipts.
Example 2: Method A – expenses and capital allowances are deducted
Nathalie lets out two rooms in her home. Each room is let for £120 per week, and Nathalie receives rental income of £12,480 in 2017/18.
She also incurs expenses in relation to the lets of £4,375 in 2017/18.
Under Method A, her taxable rental profit is £8,105.
Under Method B, tax is payable on rental profits to the extent that they exceed the rent-a-room limit of £7,500 (or £3,750 as appropriate). Under this method, there is no deduction for expenses or capital allowances.
Example 3: Method B – tax is paid on rental profit with no deductions
Assume the facts are as in the example above. Nathalie’s rental receipts for 2017/18 are £12,480.
Under Method B she will pay tax on £4,980 (i.e. £12,480 - £7,500).
Which Method Should be Used for Rent-A-Room Relief?
Where rental receipts from letting a furnished room in the landlord’s only or main house exceed the rent-a-room limit, HMRC will automatically work out the profit using Method A (the normal rules).
Consequently, where a better result (i.e. a lower taxable profit) is obtained using Method B, as is the case in the above examples, the landlord will need to tell HMRC that they wish to pay tax under Method B. This must be done by the normal self-assessment deadline of 31 January after the end of the tax year. Once the landlord has elected for Method B to apply, it will continue to apply until such time as the landlord tells HMRC they wish to swap back to Method A. Where gross rental income drops below the rent-a-room limit, rent-a-room relief will once again apply automatically unless the landlord opts out of the scheme.
Which rent-a-room method works out best?
A better result will be obtained under Method A if expenses and capital allowances exceed the rent-a-room relief limit, whereas a better result will be obtained under Method B if expenses and capital allowances are less than £7,500 (or £3,750, appropriate). Determine which scenario applies and elect accordingly.
Losses may not carry over if you claim rent-a-room relief
Even where gross rental receipts are below the rent-a-room limit (and therefore automatically exempt from tax), the scheme will not always be beneficial.
Where expenses exceed rental receipts, such that the landlord makes a loss, the benefit of that loss will be lost under the rent-a-room scheme.
Where a loss arises, it can generally be carried forward and used against future profits of the rental business. The ability to use the loss may be beneficial if the landlord lets out other properties on which he makes a rental profit, or if it is likely that in the future the rental receipts from letting rooms in his or home will exceed the rent-a-room limit, giving rise to a taxable profit.
The losses can be used regardless of whether the subsequent profit is worked out under Method A or Method B.
Example 4: Losses and rent-a-room relief
In 2017/18, James lets out a room in his home. He receives rental receipts of £1,500 and incurs expenses of £2,000.
If James does nothing, the rent-a-room scheme will apply automatically, and while this will mean that there is no tax for James to pay on his rental receipts, he will lose the benefit of the loss. Instead, James can opt out of the rent-a-room scheme by telling HMRC that he does not want it to apply. The deadline for opting out of the scheme is 31 January after the end of the tax year. This can be done on the self-assessment tax return or in writing.
Suppose that in 2018/19 James decides to let out a second room and receives rental income for the year of £8,500. His expenses are £2,000. Consequently, it is beneficial for him to work out his taxable profit under Method B, giving rise to a taxable profit of £1,000 (compared to £6,500 if Method A is used). James can set the 2017/18 loss of £500 against the 2018/19 profit of £1,000, reducing the taxable profit in 2018/19 to £500.
James must remember to tell HMRC that he wants to use Method B to work out his profit.
Practical tip for using rent-a-room relief:
Whilst rent-a-room relief means that rental profits from letting out a room in your home can be ignored if gross receipts are less than the rent-a-room limit (i.e. £7,500 or £3,750), the scheme will not always be beneficial. Do the sums each year and choose the option which gives the best result, remembering to tell HMRC by 31 January if you want to opt out of the scheme or switch between Method A and Method B where receipts exceed the rent-a-room limit.
