PIM1094 - Cash basis for landlords: receipts and expenses
Receipts
The total amount of receipts of the property business to be brought into account in calculating profits or losses under the cash basis are those received during the tax year, subject to any adjustment required or authorised by law. This means that no adjustments are needed for debtors, for example.
Example
Mr R uses the cash basis.
He begins renting out an office from 1 July 2017. The tenant pays rent of £4,000 in advance every 6 months, due 1 July and 1 January.
The tenant pays the rent when it becomes due on 1 January 2018. As the rent paid on 1 January 2018 relates to the rental period from 1 January to 30 June 2018, the period straddles the 2017-18 and 2018-19 tax years.
Under GAAP, an adjustment would need to be made to apportion the £4000 rental income across the two tax years.
However, as Mr R is using the cash basis, he simply recognises the rental income when it is received. He therefore recognises the full £4,000 in the 2017-18 tax year. There is no need to apportion.
Example
£4,000 rent becomes due from Mr R’s tenant on 1 January 2019. However, the tenant encounters cash flow issues, and is not able to pay the rent until 28 April 2019. Even though the rent was partly earned in the 2018-19 tax year, Mr R brings the full amount into account when it is paid in the 2019-20 tax year.
Post-cessation Receipts
If a property business ceases in a cash basis tax year, a receipt received after the date of cessation is chargeable to tax if it would have been brought into account in calculating the profits under cash basis had it been received immediately before cessation.
Example
Mr M lets out a flat, calculating his profits using the cash basis.
Mr M sells the flat to fund an extension on his home. The sale is completed on 31 March 2020, and his property business ceases on that date.
His tenant is late paying the rent for the final month of the tenancy, paying on 14 April 2020. As this would have been brought into account on 14 April 2020 under the cash basis had that date been immediately before cessation, it is treated as a post-cessation receipt and charged to tax in the 2020-21 tax year.
Security Deposits and Bonds
Tenants may pay deposits to landlords to cover the costs of repairing damage to the property sustained during their tenancy. It will often be held in a custodial or insurance scheme during this period and returned to the tenant at the end of the tenancy, less any deductions made for damage to the property. The amount of the deposit is still legally retained by the tenant for the duration of the tenancy.
As the amount of the deposit is still legally held by the tenant and not the landlord, the deposit or a part of it is only recognised as a receipt under the cash basis when the landlord becomes legally entitled to retain that amount at the end of the tenancy.
Example
Mr F enters into a new tenancy agreement to let a residential property during the 2019-20 tax year.
As part of the agreement, the tenant pays a security deposit of £1100. This amount is paid into a deposit protection scheme and so is not included in the income of Mr F’s property business for the 2019-20 tax year.
The tenancy ends 12 months later during the 2020-21 tax year. It is agreed that £300 will be deducted from the deposit to cover the cost of repairing damage the fixtures in the property. Mr F becomes legally entitled to the £300 at this time. Under the cash basis he must bring the amount into account when calculating his property income profits for the 2020-21 tax year. The remaining £800 is returned to the tenant and is never brought into account as income.
Amounts Paid to Agents on Behalf of the Landlord
Agents may take payments for rent on behalf of a landlord. For example, a residential landlord may use a property management company to collect rental payments, or a person with a furnished holiday letting business may list their property on a website that facilitates card payments on behalf of the owner.
If a landlord uses an agent to collect payments and calculates the profits of their property business under the cash basis, income will be recognised when it is paid to the agent and not when the agent passes this on to the landlord.
If the agent fails to pass on any payments, the income must still be recognised when it was paid to the agent.
Expenses
Under the cash basis, the total amount of expenses of the trade to be brought into account in calculating profits or losses are those paid during the tax year, subject to any adjustment required or authorised by law (e.g. for the wholly and exclusively rule). A property business using the cash basis will not need to account for creditors or bad and doubtful debts.
Example
Ms J pays a cleaning company to clean her rental property once a week. She is invoiced quarterly on the last day of March, June, September and December for work completed over the previous three months, with time to pay of one month.
Jackie receives an invoice for £200 on 31 March 2020. She then pays the amount on 22 April 2020.
Under GAAP, Jackie would bring the expenditure into account when she is invoiced on 31 March 2020, deducting the amount from her profits for the 2019-20 tax year.
Under the cash basis, she brings the £200 into account when she pays on 22 April 2020, deducting the amount from her profits for the 2020-21 tax year.
Calculating profits or losses of a trade using the cash basis does not usually affect the types of expenses which are allowable, with the exception of the specific rules on deductions for the cost and loans and for capital expenditure.
Cost of Loans
Under the cash basis for property income, deductions for the cost of finance are allowed, but there are additional restrictions further to those applied on other residential property businesses since 6 April 2017 (see PIM2054).
The costs of a loan includes:
- Interest on the loan; and
- Incidental costs of obtaining finance, such as fees, commissions, advertising and printing
Under sections 307C and 307D of the Income Tax (Trading and Other Income) Act 2005, the restriction applies where the total of the loans (or the parts of loans used wholly and exclusively for the purposes of the property business) is greater than the total value of all properties involved in the property business. In this calculation, the total value includes:
- The market value of each property when it is first involved in the property business; and
- The total capital expenditure incurred by the person carrying on the business that has not already been brought into account as a deduction in any tax year
If this amount is less than the total of the loans, the deduction for the cost of the loan is restricted as follows:
Cost of loan multiplied by Value of properties involved in business divided by Total amount of the loan used in the property business.
This amount is then further restricted by the restriction on deductions for the costs of loans used to buy residential let properties (see PIM2054).
Example
Miss J begins using the cash basis for her property business in the 2017-18 tax year.
She rents out two properties:
- A maisonette
- A basement flat below the terraced house in which she lives.
Miss J took out two mortgages to fund the purchase of these properties: one of £150,000 for the maisonette, and one of £350,000 which covers the entire freehold of her terraced house and the basement flat below it.
Miss J pays £500 in interest a year on the mortgage for her maisonette. She also pays £1500 a year in interest on the mortgage for the terrace freehold. However, as only the basement flat is let as part of the property business, the amount of the deduction is restricted by reference to the specific circumstances. As the part of the property she occupies covers around two thirds of the entire property, £1000 (i.e. two thirds) of the interest deduction is disallowed in calculating his profit as it is not wholly and exclusively for the purposes of the property business. This leaves only £500 that may be deducted.
As Miss J is using the cash basis, the total £1000 deduction that is available may be subject to the cost of loan restriction.
In order to check whether the restriction applies, the total amount of the loans used wholly and exclusively for the purposes of the property must be calculated:
| Mortgage on maisonette | £150,000 |
| Mortgage on freehold | £350,000 |
| Less amount not related to basement flat | (£250,000) |
| Total | £250,000 |
Miss J must then compare this to the value of the properties. She incurred £10,000 of capital expenditure on converting the basement into a flat. However, the housing market slumped before she began renting it out as part of her property business, and it was only worth £80,000 at the time she began to rent it out. For the purposes of the restriction, the market value is calculated as:
| Market value of maisonette when brought into property business | £150,000 |
| Market value of basement flat when brought into property business | £80,000 |
| Capital expenditure incurred on basement flat | £10,000 |
| Total value | £240,000 |
As the total amount of the loans used in the property business (£250,000) is greater than the value of the properties (£240,000), the restriction is applied to the deduction for the cost of the loans, which is the £1000 mortgage interest.
£1,000 x £240,000/£250,000 = £960
Under the cash basis, Miss J may only deduct £960 when calculating her 2017-18 profits.
As Miss J is renting out residential property, the deduction is also further restricted by the general finance cost restriction (see PIM2054).