CAPITAL GAINS TAX AND CAPITAL EXPENDITURE

Where’s GSM ? Really miss her….

It sounds as if your accountant has already told you the answer.
I’ve one property which I rent out, and like you, I’ve improved it over the years and replacing floor coverings, the boiler, kitchen and one bathroom over the years, not to mention re-decoration between tenants.
However, I’ve just considered that part of keeping the property up to date and of course making it more attractive to prospective tenants - there’s never been a significant gap between them.
As you’ve found, the allowable profit before GCT kicks in has been significantly reduced. My property hasn’t gained much in resale terms in the 14 years I’ve owned it (from new) but I consider I’ve made my ‘profit’ in rental income.

… capital expenditure is only structural changes like a new extension that adds value to the property.

That isn’t strictly true although distinguishing between revenue expenditure and capital expenditure can be tricky.

Bear in mind that just because an item is brand new does not make it an improvement over an item which has been in use for several years and suffered general wear and tear.

It’s always a good idea to refer to the HMRC manual on these kinds of questions:

www.gov.uk/hmrc-internal-manuals/property-income-manual/pim2030

Key questions are whether the expenditure had extended the life of the property or provided an additional asset.

Note what it says in the HMRC manual:

Problems can arise where the customer does work on an old asset. A repair or replacement of a part of a building using modern materials may give an apparent element of improvement because of the greater durability, superior qualities and so forth of the new material. But the cost normally remains revenue expenditure where any improvement arises only because the customer uses new materials that are broadly equivalent to the old materials.

Were you to replace a kitchen or bathroom with something of superior quality to the old one (irrespective of the condition of the old one) then that could constitute capex. Replacing an old 1970s MFI kitchen with something high-end bespoke and luxurious, for example, could be considered an additional asset. But replace an old 1970s MFI kitchen with a budget kitchen from Wickes and that would be revenue expediture.

In a way, you have answered your own question. You spent the money to make the property more attractive to potential tenants, presumably to achieve higher revenue. Even tired, tatty properties will find a tenant albeit at a lower rent. You incurred revenue expenditure to achieve revenue.

There are some special rules relating to expenditure on dilapidated properties - see under Repairs after a property is acquired in the HMRC manual. The rewiring could be claimed as capex.

You are out of time to claim non-capex items against revenue.

When I owned a flat that I let out and generally maintained and kept uptodate and in good order, there was an annual allowance to cover all the general maaintenance. Either you claimed the amount of specific invoices, or you had an allowance of something like, 10% of revenue.

It is generally considered that money you spend to keep ia property up to date and in good order will be recouped through the price - and you pay capital gains tax on this.

In practice a property owner would claim the cost of improvements as repairs and maintenence if possible because that gives immediate relief of Income Tax. If he owns several properties refurbishing one completely in a tax year might be within the limits allowed, it’s more difficult if only one property is owned.

David49

In practice a property owner would claim the cost of improvements as repairs and maintenence if possible because that gives immediate relief of Income Tax. If he owns several properties refurbishing one completely in a tax year might be within the limits allowed, it’s more difficult if only one property is owned.

OP owns three flats. It should be possible to rotate refurbishments to maximise tax relief, but (as Silverbrooks has pointed out) she is now out-of-time to claim it on past improvements.

My exDH has a property portfolio and I know he is constantly refurbishing and timing the sales of the properties to maximise tax relief.

Thanks to all for your help so far. It looks like we should have claimed improvements as revenue whereas we thought they were capital.
It is disappointing but our records for a lot of the refurbishment expenditure are not very detailed, so even if we had tried to claim more of the bills as capital expenditure at the right time, we wouldn't have had sufficient *evidence" to show HMRC if they had decided to investigate.
Of course there must be plenty of people who claim anyway to reduce their tax bills but I wouldn't sleep at night if I did that.

If you let, carpets, curtains, paint, heating systems and even bathrooms and kitchens should be replaced at various intervals anyway, if you're going to keep a habitable property. That's why they're revenue expenditure - they're legitimate business expenses, just like the annual gas check and periodic electricity and fire/CO2 alarm checks. They possibly won't affect the value of the property for resale - except that if you keep a property for a long time and don't do anything, you'll end up with a property which needs modernisation (and sells for less).

PS. Make sure you keep detailed records/receipts and don't pay people cash in hand.

Ramblingrose22

Thanks to all for your help so far. It looks like we should have claimed improvements as revenue whereas we thought they were capital.
It is disappointing but our records for a lot of the refurbishment expenditure are not very detailed, so even if we had tried to claim more of the bills as capital expenditure at the right time, we wouldn't have had sufficient *evidence" to show HMRC if they had decided to investigate.
Of course there must be plenty of people who claim anyway to reduce their tax bills but I wouldn't sleep at night if I did that.

As they say, 'with due respect' Surely you should have sorted out the tax and accounting regime when you and your co-owners inherited the property 12 years ago. Kept proper accounts and kept the necessary receipts.

Problems like yours arise because of the failure of people to act in a business like way at the start of an enterprise and blame others for their failure when they end up in a mess like this at the end.

I'm not sure it's such a "mess" *MOnica". Presumably OP has had rental income since owning the flats, which (if reasonably managed) will have been far more than she could have earned in interest from any bank account over the last 12 years. When the properties are sold, I'd be amazed if there isn't some profit (if there isn't, CGT won't be a worry), so she hasn't done too badly.

I agree with you about acting in a business-like manner. Too many landlords seem to think they can cut corners by not employing accountants and/or legitimate maintenance contractors.

I think M0nica and growstuff are making a lot of unkind and incorrect assumptions about the way we have conducted our affairs as landlords. M0nica. - how do you know that we have never kept proper accounts and the "necessary receipts"???And whom exactly are we blaming?

I respectfully suggest that you base your opinions on evidence and refrain from making insulting assumptions about people you don't even know.

We have never been the kind of landlords that think we "can cut corners" and who pay people in cash and M0nica has no evidence to suggest this in relation to us. We have always used accountants for our accounts but unfortunately we didn't check with her about the treatment of improvements because we sincerely believed that improvements were capital expenditure.

This is evidenced by the fact that if we had known our improvements were revenue and not capital at the time we have deliberately done ourselves out of money by allowing ourselves to have a higher capital gains tax bill.

I am sorry that some people on gransnet seek to belittle others who are "guilty" of nothing more than having made a mistake. Fortunately, they are few and far between.

In practice it’s very difficult to do major refurbishment with a tenant in the property, a new bathroom or kitchen often isn’t possible and the tenant doesn’t always cooperate. Decorating may be able to be done although that’s often a challenge.

Ramblingrose22 but is as you yourself say unfortunately we didn't check with her(your accountant) about the treatment of improvements because we sincerely believed that improvements were capital expenditure.

What is that if not keeping proper accounts?. You should have checked everything and got proper advice. In fact if your accountant did not discuss this all through with you, then you may well have a claim against her for your oversight. She was/is the accountant and should have advised you accordingly.

I never suggested you cut corners or paid people in cash. It never occurred to me that you would, and anyway, if you claimed the annual allowance, you could do that without any problem.

I had a rental flat for some years, mostly one year student lets and went in every year between tenants to make sure all was in good order and any repairs were made. I planned major improvements ahead of tenancy changes so that the workmen went in the day after the students left.

I do apreciate that this less easy wth a long term tenant. DD has just bought a house after a long-term tenant moved out and they left the house in a shocking condition, much of it not obvious until the house was empty.

David49 - we ensured that the flats had all been vacated by the tenants in order for the works to be carried out.

Ramblingrose22 You, yourself, wrote "our records for a lot of the refurbishment expenditure are not very detailed" - I didn't know what that meant, but I know that I keep every receipt for everything I know might be tax-deductible. It was lax of your accountant, if that didn't happen.

David49 My ex has a property portfolio, which is his main source of income. When we were married, I knew what he was doing and was involved with some of it - my children still give me general news and my son gets involved with the management. My ex is a qualified surveyor and my son has an MSc currently employed as a social housing specialist. I've also been a tenant in my current house for 11 years, so I see rentals from both sides of the fence.

My ex has mainly medium-term tenants and completely redecorates between most rentals. Kitchens and bathrooms are replaced as standard every 10 years. He employs a maintenance firm on a more or less permanent basis. He also has an accountant, so everything is logged.

In the 11 years I've lived in this property, I've had all the kitchen white goods replaced, the whole exterior of the house has been repainted, fences and my garden shed roof have been replaced, some rewiring was done and light fittings replaced, a radiator was replaced, two carpets have been replaced, all my taps have been replaced and I'm waiting at this moment for somebody to fit a water softener. I've done some minor maintenance work myself after informing the landlord.

Both my immediate neighbours are tenants and I know they're the same as I am. We keep our houses/gardens clean and well-maintained, but our landlords do major jobs. Not all tenants are "shocking", especially if the properties are well-maintained in the first place and there is mutual respect. Letting properties is a serious business, so people need to research everything - including tax rules - when doing it.

MOnica With regards to the property your DD has bought - it was the landlords's responsibility to check that the house wasn't in a shocking condition. Some of the costs of any damage would have been recouped from the damage deposit, but it sounds as though the landlord didn't use the money to rectify the situation.

I get a tad fed up with the stereotype of tenants as irresponsible house-wreckers.

Well, I was seeking advice/help as so may of us do on Gransnet. Up to now I have always found others very helpful and constructive. It seems that some people on here simply like to kick people when they are down.

You do yourself no favours. And can you honestly say that you have never made a mistake? Pull the other one......!

I don't intend to dignify M0nica's or growstuff's ignorant and unevidenced comments with any further replies.

Fair enough Ramblingrose22, although I don't agree that my posts have been ignorant.

and blame others for their failure when they end up in a mess like this at the end.

I agree that the criticism was harsh and unwarranted. I don’t think you are blaming anyone other than yourself and your co owners. You simply asked a question about what constitutes revenue expenditure and capital expenditure. You followed that up with the comment:

a lot of the refurbishment expenditure are not very detailed, so even if we had tried to claim …

I took that to mean (say) you had the property rewired (capex) but there may have been other small electrical items in there e.g. some new light fittings or energy efficient bulbs (revenue).

As a tax professional (retired), I was asked the same question many, many times. A lot of people make the same assumptions you did. And, some accountants will give you a different answer - which I why I always advise going back to the HMRC manuals. But how many lay people would know to do that?

But let’s look at the practical implications here.

The rate of CGT is going to be between 18% and 24% depending on your individual margin rates.

The rate of income tax in those years of outlay was 20% or 40%, as they are now.

Say £10,000 was spent on each flat, a total of £30,000. Say it was all revenue expenditure that wasn’t claimed against tax and is now out of time to do so.

If you all have a marginal income tax rate of 40%, the maximum you have lost in not claiming for revenue expenses would be £30,000 x 40% = £12,000.00 split three ways. At 20% is would be £6,000 split three ways.

Assuming no local factors have adversely affected property values, the capital gain over 12 years should be substantial. You inherited the property so will bring in the probate value as the “cost” price.

If all that £30,000 was claimable as capex and you all have a marginal CGT rate of 24%, it would save £7,200 in CGT split three ways.

So, each of you have lost at most £4,000, if the expenditure was £30,000. Obviously, you need to scale that up if you spent more.

Nobody wants to pay more tax than they have to (other than the Patriotic Millionaires) but I suspect measured against the gain you will realise, it’s a relatively small amount.

For the record you don’t have to receipt everything unless asked to do so, else HMRC would be swimming in bits of paper. HMRC aren’t going to quibble over £30 spent on say energy efficient lightbulbs or a lampshade but they would expect you to be able to prove major expenditure if asked, not only to show you paid those amounts but as evidence of potential evasion by others if you can’t.

If someone was under investigation and no paper evidence could be produced from 12 years ago, HMRC would ask to see some banking evidence of the payment. If someone were to claim £5,000 for rewiring and claimed they had no receipt and had no banking evidence of having paid the contractor, HMRC would disallow the claim and also ask for names and dates so they could have a wee look at the contractors accounting as well.

growstuff

MOnica With regards to the property your DD has bought - it was the landlords's responsibility to check that the house wasn't in a shocking condition. Some of the costs of any damage would have been recouped from the damage deposit, but it sounds as though the landlord didn't use the money to rectify the situation.

I get a tad fed up with the stereotype of tenants as irresponsible house-wreckers.

The house was checked, but it is only when you pull the carpets up and end up with flea bites on your legs, that you realise there was an infestation of cat fleas. A blockage in the kitchen drain was hidden behind the foliage in the over grown garden. It was part functional so not immediately obvious. It is when DD start using the DW regularly and empty cleaning suds down the sink, and generally actually using water in the kitchen, that the problem became clear.

We too had walked round the house with DD and thought things looked reasonable, not brilliant, but reasonable. But then DD started cleaning behind radiators - and of course the fleas. The owners never went near it once the tenants were out. They were selling the property because they were financially overstretched and just wanted to get shot of the house and get hold of the money. Why should they care? the house wasn't theirs to worry about once it was sold.

I would never denigrate tenants. I rented out a property for 7-8 years and all my tenants bar 1 were fine.

I don't intend to dignify M0nica's or growstuff's ignorant and unevidenced comments with any further replies.

Much the same argument as that used by the guys who cut down the Sycamore in Sycamore Gap, denying their own words and action.

Dear Silverbrooks, thank you so much for your helpful and informative contribution.

It is a pity that others think it justified to use a request for help to make incorrect assumptions about people they don't even know and insult them into the bargain.

I will study what you have said carefully and try scaling up the amounts spent on each flat to see what our CGT bill might be. I think there are also worksheets you can use where you input the acquisition value, the sale value and the allowable costs.

I will have another look for those.

Thanks once again.

crazyH

Where’s GSM ? Really miss her….

The first thing the new owners will do is rip out a kitchen and a bathroom and do it to their own taste. I have always been advised none of this adds value to a property. We added two extensions to our bungalow and that has added an enormous amount to the value to our property. So yes you have had the right advice.