Cash basis accounting trouble for new landlords

Cash basis

Since April 2017, landlords have been required to prepare their property rental accounts for their tax returns using the cash basis, although there are exceptions. This means your taxable income and deductible expenses are the rents etc. received and expenses paid respectively instead of the usual income receivable and expenses incurred. The cash basis seems to preclude tax deductions for expenses paid prior to letting.

Start date

To determine if an expense is paid before your rental business begins you must first know what the start date was. HMRC says a rental business “begins when letting first commences“, i.e. when the first rental agreement or lease is signed.

Example. On 1 May 2023 Jack and Jill buy a property which they intend to let as soon as possible. They incur renovation and redecorating expenses to make the property more marketable for letting, fees for advertising and admin, plus a service charge to the head leaseholder. They first grant a rental licence to tenants on 1 July 2023. The licence begins on 1 August 2023. HMRC might say that the business begins on 1 July. We would argue it starts as soon as the property is fit for letting and Jack and Jill advertise it. However, the exact date is usually academic.

Using HMRC’s interpretation, none of the redecoration and other expenses, e.g. the service charge, paid before 1 July 2023 are tax deductible. HMRC categorises these expenses as preparatory to letting and not in the course of the letting business. The good news is that HMRC’s seemingly miserly approach doesn’t prevent the pre-letting expenses being tax deductible.

The “pre-trading expenses” rule trumps the normal rules by allowing a deduction for the expenses incurred as if you had paid them on the day that your rental income business commenced.

A pre-trading expense only qualifies for a tax deduction if it would have been deductible had it been paid after the rental business commenced. For example, if a pre-trade expense was for building work to knock down a wall to make two rooms into one, that’s a capital expense which is not deductible for working out profit but may be allowed as a deduction when calculating any capital gain or loss when you sell the property.

Example. The expenses incurred by Jack and Jill from our previous example are £1,500 renovation, £2,000 redecoration, £200 advertising and £3,000 service charge for the period 1 June to 30 November 2023 all paid before the start of the rental business. The £1,500 renovation is a capital cost and not deductible in arriving at the profit. The £2,000 and £200 for redecoration and advertising are deductible from profits because of the pre-trading rules. The deduction for the service charge in this example is the full £3,000, but if there was any private use of the property before or after the business commenced, the deduction must be reduced by time apportionment to reflect the amount of private use.