Sarah Bradford takes a look at the ‘rent-a-room’ scheme following the Chancellor’s announcement that the limit is to be increased to £7,500 from April 2016.
The rent-a-room scheme allows both owner-occupiers and tenants to let out a room or rooms in their only or main home and receive rental income up to the rent-a-room limit tax-free.
The limit has been set at £4,250 a year since the introduction of the scheme 18 years ago. However, in his summer 2015 Budget the Chancellor announced that, from April 2016, the limit is to be raised to £7,500, making it possible to earn up to £7,500 tax-free by letting out spare rooms in your home.
How does the scheme work?
Under the rent-a-room scheme, profits made on renting a room in your house are tax-free as long as gross receipts do not exceed the annual rent-a-room limit, i.e. £4,250 for 2015/16, rising to £7,500 from next year. The tax exemption is given automatically if rents from letting a room in your home are less than the limit. If the rental is more than the limit, it is necessary to complete a tax return and to claim the rent-a-room allowance, if it is beneficial to do so.
The limits applies to gross rents before taking account of any expenses, but including amounts that are paid by the lodger for the provision of any meals, or services such as cleaning and laundry.
Example 1: Rent below the rent-a-room relief limit
Ruth lets out her spare room and receives rental income of £3,500 a year. As this is less than the rent-a-room limit, she does not need to complete a tax return or tell HMRC.
The rent-a-room relief is given automatically and her rental income is free of tax.
Participation optional
Participation in the scheme is not compulsory, and instead profits and losses can be computed in the normal way. This may be beneficial either where there is a loss or where computing profits in the normal way provides a lower taxable profit.
Rents exceed the rent-a-room limit
If gross rents are more than the rent-a-room limit, the taxable amount can be worked out in one of two ways:
- Method A (rent-a-room relief not claimed) – deduct expenses from income in the normal way to work out the taxable profit; or
- Method B (rent-a-room relief claimed) – deduct the rent-a-room limit from gross receipts to arrive at the profit.
Method A is the default, which HMRC use automatically. If you want to use Method B, you need to tell HMRC.
Tip:
Do the maths to see which gives the best result.
Trap:
The rent-a-room limit is reduced where the property is owned by more than one person (see below).
Example 2: Method A or Method B?
Josie lets out her spare room and receives gross rental income of £6,000 in 2015/16. Her expenses are £2,000.
If she does not claim rent-a-room relief, her profit is £4,000 (£6,000 - £2,000). However, by claiming rent-a-room relief, her profit is only £1,750 (£6,000 - £4,250). If she is a higher rate taxpayer, claiming the relief will save her £900 in tax (40% (£4000 - £1,750)).
If, however, her expenses had been £5,000, it would have been better not to have claimed rent-a-room relief, as using Method A her profit would be £1,000 compared to £1,500 under Method B applying rent-a-room relief.
For 2016/17, assuming her gross rent stays the same her profit will be exempt from tax automatically, as they are below the new limit of £7,500.
Trap:
HMRC will use Method A automatically. If Method B is better for you and you want to claim rent-a-room relief, you need to tell HMRC.
Losses
Claiming rent-a-room relief is not worthwhile if a loss is made. It is always better to work out the actual loss and claim relief for that loss.
Where expenses exceed rental income and receipts exceed the rent-a-room limit, Method A will always be preferable. Where receipts are less than the rent-a-room limit, it will be beneficial for the rent-a-room scheme not to apply. This will ensure that relief can be given for the losses.
Where losses are brought forward, they can be set against any taxable profit from the rent-a-room letting, regardless of how those profits are calculated. To the extent that they cannot be utilised, they can be carried forward for offset against any future profits.
Example 3: Preserving losses
Maude lets out a room in her home. She receives gross rent for 2015/16 of £2,000. However, she incurs expenses of £2,500.
As her rents are below the rent-a-room relief, the tax exemption is in point. However, under rent-a-room she loses the benefit of her loss.
By opting out of the scheme she can preserve the loss of £500 and carry it forward. This may save her tax in the future.
Joint owners
If more than one person receives income from letting accommodation in the same property (which may be the case where the property is jointly owned), each person is entitled to rent tax-free up to the level of half the rent-a-room limit. For 2015/16, this is £2,125 (50% of £4,250). For 2016/17, each person can receive tax-free rental income of up to £3,250 (50% of £7,500).
Where more than two people receive income from let accommodation in the property, it is possible to receive tax-free income in excess of the rent-a-room threshold, as the tax-free amount stays at 50% of the limit, regardless of whether income is received by two people or by ten people.
Example 4: Three joint owners
Alex, Amy and Anna are siblings, and buy a property together. To help them pay the mortgage and the bills, they let out their spare room. They receive gross rental income of £6,000, which they share equally. Each person receives £2,000 in rent.
As this is less than their individual rent-a-room limit for 2015/16 of £2,125, the tax exemption applies automatically. The whole £6,000 of rental income is received tax-free, despite the fact that it is £1,750 more than the rent-a-room threshold of £4,250 for 2015/16.
Time limits
If your gross receipts are above the rent-a-room limit, and you want to claim the relief and use Method B to work out your profit, you need to tell HMRC no later than 31 January after the end of the tax year. Therefore, the time limit for claiming the relief for 2015/16 is 31 January 2017.
Tip:
Once you have chosen Method B you are not stuck with it. If Method A is beneficial, all you need to do is tell HMRC by 31 January after the end of the tax year that you do not want Method B to apply. You can opt in and out of Method B each year, depending which gives the best result.
Similarly, if your receipts are below the limit and you do not want rent-a-room to apply automatically (e.g. if you have made a loss and want preserve that loss), you must opt out of rent-a-room by the same date.
Practical Tip:
The increase in the rent-a-room limit to £7,500 from 6 April 2016 will also save work as, where gross rents are below this level, the tax exemption will apply automatically. However, if gross rents are above this level or you make a loss, you will still need to do the maths and, where necessary, opt in or out of rent-a-room relief, as appropriate.
