Not All Lettings Are Equal!

Sarah Bradford compares the tax rules for furnished holiday lettings with other types of lettings.

For tax purposes, not all lettings are equal. Furnished holiday lettings enjoy some tax advantages, which are not available to other types of lettings.

Basic rules

As a basic rule, profits from letting land or property in the UK are treated for tax purposes as arising from a business. All rental business activities carried on by the same persons in the same legal capacity in the UK are treated as forming a single UK property business. Similarly, where property is let overseas, income from all properties carried on by the same persons in the same legal capacity is treated as part of a single overseas property business.

The profits of a UK property business are computed in the same way as the profits of a trade. However, crucially, a property rental business is not a trade and as such does not benefit from the reliefs available for traders, such as the capital gains tax (CGT) reliefs.

Exception to the basic rule

Special rules apply to furnished holiday lettings (FHLs) as, unlike other lettings, FHLs are treated as a trade for some purposes (but not for all purposes). This means that, unlike other lettings, they are able entitled to plant and machinery capital allowances and able to benefit from the CGT reliefs available for traders.

To ensure that the special rules apply only to FHLs, the profit from FHLs does not form part of the property rental business, but must instead be computed separately.

It should be noted that the rules applying to FHLs were tightened from 2011/12. As a result, the qualifying tests are more stringent than they were in the past, and also trade loss relief is no longer available in respect of any losses in respect of FHLs.

What lettings are furnished holiday lettings?

Only lettings that meet the qualifying tests for FHLs enjoy the associated tax advantages. Lettings that do not meet the tests, even if they are short term lets in tourist areas and are described as holiday lettings, are not FHLs for tax purposes and instead profits are taken into account in computing the profits of the property rental business, together with other properties owned by the same persons in the same legal capacity.

To qualify as a FHL, the accommodation must be in the UK or the EEA and must be let on a commercial basis. A letting is on a commercial basis if it is let with a view to making a profit. Also, as the name suggests, the accommodation must be furnished rather than unfurnished. A letting is regarded as furnished if sufficient furniture is provided for normal occupation. For tax purposes, UK and EEA FHLs are treated as separate businesses.

Once these criteria have been met, it is necessary to consider whether the let meets the qualifying test.

Qualifying tests

In order to qualifying for the tax advantages available in respect of FHLs, three tests must be met (in ITTOIA 2005, s 325). The tests are set out below (as they apply for 2013/14 onwards):

Test 1 – the availability condition (availability test/threshold).

The accommodation is available for commercial letting as holiday accommodation for at least 210 days in the year.

Test 2 – the letting condition (occupancy test/threshold)

The accommodation is commercially let as holiday accommodation for at least 105 days in the year.

Test 3 – the pattern of occupation condition

The accommodation must not be let for period of longer-term occupation for more than 155 days in the year.

The test period is the tax year where the let is ongoing. If the let was not a FHL in the previous tax year, the tests are applied to the first 12 months of letting. Where the property ceases to be let as furnished holiday accommodation, the qualifying tests are applied by reference to the final 12 months of letting.

Meeting the tests

The first test (the availability condition) is straightforward and is simple a count of the number of days in the year on which the property is available for commercial letting as a FHL. When counting the days, any days on which the owner occupies the property are not taken into account. The ‘magic number’ is 210.

The second test (the occupancy threshold) measures the number of days for which the property is commercially let as a FHL in the year. For this test, the magic number is 105. Although, at first sight, this would appear to be fairly straightforward measure, there are two elections that can be utilised if help is needed in meeting this test.

Averaging election

Where a taxpayer has more than one property let as FHLs, an averaging election can be useful if the occupancy threshold is met in some but not all of the properties. Averaging can only be used across properties in a single furnished holiday lettings business – it is not possible to average UK and EEA lets.

Example - Occupancy test

Harry has three seaside cottages in the UK, Lavender cottage, Honeysuckle cottage and Rose Cottage, which he lets as furnished holiday accommodation. In 2013/14, the number of days each cottage was so let was as follows:

Cottage Number of days actually let as furnished holiday accommodation

Lavender Cottage 111

Honeysuckle Cottage 120

Rose Cottage 96

Total 327

On a strict application, Lavender Cottage and Honeysuckle Cottage would meet the occupancy test, whereas Rose Cottage would fail as it was only actually let as furnished holiday accommodation for 96 days in 2013/14.

However, the three properties were in total let as furnished holiday accommodation for 327 days in the tax year, an average of 109 days (more than the requisite 105 days). By applying for averaging, all three cottages meet the test. An averaging election can be made on the self-assessment tax return and must be made by the anniversary of 31 January following the end of the tax year to which it relates (i.e. an averaging election for 2013/14 must be made by 31 January 2016).

Thus where more than one property is let as furnished holiday accommodation, consider an averaging election if the properties do not all meet the occupancy test individually.

‘Period of grace’ election

The second tool in the occupancy test toolbox is a ‘period of grace’ election, which was introduced to smooth the transition from a previous occupancy requirement of 70 days to the current level of 105 days. The election allows a year to be treated as a qualifying year for FHL purposes where the occupancy test was not met in that year, either individually or by averaging, but there was a genuine intention to meet it and the occupancy threshold was met in the year before the first period of grace election, (either individually or as a result of an averaging election).

Where a period of grace election has been made, the property can also be treated as meeting the occupancy condition in the following year if it is not actually met. However, if the test is not met in the next year, the property is no longer treated as a FHL. It should be noted that, in 2010/11 and 2011/12, the occupancy threshold was 70 days. For a period of grace election to be accepted, it may be necessary to demonstrate that there was a genuine intention to let for at least 105 days.

Thus consider a period of grace election where actual letting falls below the requisite 105 days to secure up to two deemed qualifying years.

The nature of a holiday let is that it is for short period, typically one or two weeks. Consequently, to be regarded as a FHL for tax purposes, the property must not breach the pattern of occupation condition. This condition is breached if, for more than 155 days in the year, the property is let for lets of 31 days or more. The property can be let to the same person for more than 31 days in the year without problem, as long as each let is less than 31 days.

Advantages: FHL v other lets

A furnished property that is commercially let and which meets the qualifying tests is a FHL and benefits from the special tax rules. All other lets are taxed in accordance with the normal rules for a UK or overseas property business.

Profits and losses for FHL are worked out in the same way as for other property businesses in accordance with trading rules. However, unlike other property businesses, plant and machinery capital allowances are available in respect of FHLs, as are capital gains tax trading reliefs, including entrepreneur’s relief, business asset rollover relief, relief for gifts of business and relief for loans to traders. Profits from FHLs also count as earnings for pension purposes, unlike those from other lets.

Practical Tip:

The special rules for FHL are tax-advantageous and where possible steps should be taken to bring a let within these rules. Averaging and period of grace elections can help.