This is probably one of the most difficult cost types to define and is extremely confusing for property investors.
The guidance never seems to quite fit with the work undertaken.
Its an issue for accountants too, often the investor lists all the costs rather than the projects so you end up with lots of entries like B&Q and have to try to reshuffle them into projects like a new kitchen.
HMRC has a tool kit Capital v Revenue which gives some guidance.
In general investors want costs to be repairs (which can be deducted from profit and save tax now) where as HMRC would probably prefer improvements (which are held back and used the Capital Gains Computation when the property is sold).
In this blog I will try to give some further help aimed at owners of Buy to Let properties, the rules apply both to individual investors and those who invest via a company.
Pre-Letting Costs
The general rule is that if you buy a run down property that needs work doing on it before it can be let then that work is an improvement (capital cost).
However, if you had a letter from an letting agent saying it was lettable in its purchase condition then the works could be a repair (revenue).
If substantial work is needed, its best to discuss this with your accountant before the work is done to determine its status as an Improvement or Repair.
The important point is the property needs to in fit state to let before the alterations, refurbishment, repairs are carried out if you want the costs to be repairs.
Here is HMRC’s Guidance from PIM2030
Repairs after a property is acquired
Repairs to reinstate a worn or dilapidated asset are usually deductible as revenue expenditure. The mere fact that the customer bought the asset not long before the repairs are made does not in itself make the repair a capital expense. But a change of ownership combined with one or more additional factors may mean the expenditure is capital. Examples of such factors are:
- A property acquired that wasn’t in a fit state for use in the business until the repairs had been carried out or that couldn’t continue to be let without repairs being made shortly after acquisition.
- The price paid for the property was substantially reduced because of its dilapidated state. A deduction isn’t denied where the purchase price merely reflects the reduced value of the asset due to normal wear and tear (for example, between normal exterior painting cycles). This is so even if the customer makes the repairs just after they acquire the asset.
- The customer makes an agreement that commits them to reinstate the property to a good state of repair.
Repairs
HMRC have agreed “A replacement of a part of the “entirety” with the nearest modern equivalent is allowable as a repair for tax purposes.” (Tax Bulletin 59)
Examples
- Replacing single glazed windows with double glazed windows
- Replacing guttering with a new modern guttering
- Replacing lead pipes with copper or plastic pipes
- Replacing wooden beams with steel girders
What about Kitchens?
The following refurbishment works would be repairs
- Stripping out
- Replacing Base Units
- Replacing Wall Units
- Replacing Work Tops
- Re-tiling
- Floor repairs
- Plastering
- Wiring
Provided you are replacing with a similar standard kitchen
But if you add storage or equipment these items would be capital improvements.
There are also special rules relating to expenditure on specified parts of buildings called
‘integral features’. The following are integral features:
• an electrical system (including a lighting system)
• a cold water system
• a space or water heating system, a powered system of ventilation, air cooling or air
purification, and any floor or ceiling comprised in such a system
• a lift, an escalator or a moving walkway
• external solar shading.
Under these rules if expenditure on an integral feature represents the whole, or more than 50%,
of the cost of replacing the integral feature, then the whole of the expenditure is to be treated as
capital expenditure
Replacement of Domestic Items (RDI)
Since 2016 Replacement of Domestic Items Relief has replaced the Wear and Tear Allowance. The rules are in PIM3210.
Note – RDI is not given for the purchase of new items that are not replacements
In order for relief to be given, 4 conditions must be met:
Condition A – the individual or company looking to claim the relief must carry on a property business that includes the letting of a dwelling-house(s).
Condition B – an old domestic item that has been provided for use in the dwelling-house is replaced with the purchase of a new domestic item. The new item must be provided for the exclusive use of the lessee in that dwelling-house and the old item must no longer be available for use by the lessee.
Condition C – The expenditure on the new item must not prohibited by the wholly and exclusive rule (see BIM37000) but would otherwise be prohibited by the capital expenditure rule (see BIM35000).
Condition D – Capital Allowances must not have been claimed in respect of the expenditure on the new domestic item.
If the 4 conditions are met, then a deduction for the expenditure on the new item can be claimed.
However, a deduction is not allowed if:
- The dwelling-house in question is, in full or part, a furnished holiday letting (special rules apply to FHL’s)
- Rent-a-Room receipts have been received in respect of the dwelling-house in question and Rent-a-Room relief has been claimed in relation to those receipts.
If the new item is of broadly the same quality/standard as the old item and doesn’t represent an improvement then the deduction is the cost of the new item. Note that for these purposes, 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. For example, a brand new budget washing machine costing circa £200 is not an improvement over a 5 year old washing machine that cost around £200 at the time of purchase (or slightly less, taking into account inflation).
RDI will be given for ‘domestic items’ such as:
- Moveable furniture such as beds and free-standing wardrobes.
- Furnishings such as carpets, curtains and linen.
- Household appliances such as televisions, fridges and freezers.
- Kitchenware such as crockery and cutlery
Improvements
If an alteration increases the market value of the building, changes its function, or extends the life of the whole building then its an improvement.
We also noted under pre-letting that work to make a property lettable could be an improvement.
PIM2030 states
But there is usually no improvement if trivial increases in performance or capacity arise solely from the replacement of old materials with newer but broadly equivalent materials. For example, the replacement of pipes or storage tanks of imperial measure with the closest metric equivalent may result in slightly increased diameter or capacity but the cost is still revenue expenditure.
Where a significant improvement arises from the change of materials, the whole of the cost is capital expenditure. This includes things like redecoration after the main work has been done (redecoration would ordinarily be a revenue expense). The entire cost is capital expenditure, including the expense of making good any damage to decorations.
Alterations to a building may be so extensive as to amount to the reconstruction of the property. This will be capital expenditure and it can’t be deducted as an ordinary revenue business expense.
