Income received from letting a room in the principle residence of
the tax payer for private living accommodation to a tenant may be
accounted to HMRC in two ways.
Method A
Pay tax on the profit of gross income less expenditure.
Method B -Rent-a-Room Scheme
Pay tax on gross income less the £4,250 tax free allowance.
You can switch between the two methods to obtain the most tax
efficient solution, but you must inform HMRC which scheme you are using
in writing within specific time limits.
The Rent-a-Room Scheme was introduced by HMRC in 1995 and the current tax free income exemption of £4,250 was set in 1997.
The scheme is only applicable to qualifying individuals, not businesses or partnerships.
Qualifying Individuals
The scheme applies to lettings to an individual for the provision of
occupation in the main residence of the tax-payer. The room cannot be
let as an office, however, where the tenant performs some work or study
from the accommodation, the rules remain unaffected.
Where someone else in the same property receives income from letting
a room, the £4,250 threshold is reduced by half to £2,125 per annum.
It would be prudent for the tax payer to check that any lease or mortgage agreement allows them to take a tenant.
Qualifying Income
All income up to £4,250 that is earned from letting a furnished room
to a tenant including the provision of meals and laundry is included
under the scheme. If the income is in excess of the limit, the
additional income is subject to tax and is declared on the
self-assessment tax return form at the end of the tax year, currently 5th April 2010.
Expenditure
Expenditure that is attributable to letting the accommodation and
utility running costs may not be claimed against the income for tax
purposes. Where considerable costs have been occurred for the room to
be let, it would be advisable to calculate the net income after
expenditure to see if losses were made. If a loss has been made, it
would be beneficial not to use the scheme and declare the income and
expenditure on the self-assessment tax return. Accounting for it in
this way will enable the losses can be offset against other income for tax purposes in either the current or a future tax year.
Example where method A is better
John lets out a room in his own home for a rent of £100 a week plus
contributions to the heating and lighting. His total letting receipts
for the year from letting the room are £5,200 rent plus £200 for light
and heating = £5,400. He has expenses of £4,500 so his profit is £900.
The excess of his gross receipts over £4,250 is £1,150 (£5,400 less
£4,250).
- John pays tax on his actual profit of £900 if he uses method A.
- John pays tax on a profit of £1,150 if he uses method B.
In John's case, method A is better. Therefore he either does not
elect for method B or, if he has already done so, he tells his tax
office that he no longer wants it to apply. The profit of £900 is
included in John's overall business computation if he has other rental
business income from lettings outside his home. The profit of £900 will
be the only rental business profit if John has no other letting income.
Example where method B is better
Florence lets out a room in her own home for £100 a week. Nobody
else lets a room in the house. Her gross receipts for the year are
£5,200. She isn't exempt from tax because her gross receipts exceed the
exemption limit of £4,250. She has expenses of £1,000 so her profit is
£4,200. The excess of her receipts over £4,250 is £950 (£5,200 less
£4,250).
- Using method A, she pays tax on her actual profit of £4,200.
- Using method B, she pays tax on a profit of £950.
In Florence's case, method B is better and she elects for it. The
profit of £950 is included in Florence's overall business computation
if she has other rental business income from lettings outside her home.
The profit of £950 will be the only rental business profit if Florence
has no other letting income.