Since 6 April 2017, the default basis of preparing accounts for unincorporated property businesses is cash basis. But eligible business have a choice of cash basis or accruals basis.
The Finance Act 2017 inserted sections 271A- 271E in Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005) to cover these provisions in the legislation.
Cash basis is not available for:
incorporated property businesses that must continue to use GAAP to prepare accounts on an accrual basis
unincorporated property business whose annual rental income exceeds £150,000.
Who is eligible?
The cash basis applies by default to unincorporated property businesses which meet all the eligible criteria. Section 271A stipulates five conditions in which property business is not able to use cash basis. These conditions are:
The property business is carried on by a corporate body, say a company, a limited liability partnership, a corporate firm, the trustees, or personal representatives
The receipts for the property business are more than £150,000
For a jointly owned property with a spouse or a civil partner, one has made an election to account for the income on an accruals basis
A business premises renovation allowance is made in calculating the profits of the property business, and there is a balancing event that would give rise to a balancing adjustment
The property business has opted out of the cash basis and made an election to use the accrual basis within one year of the filing date for that tax year ie by 31 January 2019 for 2017/18.
Key features of cash basis
Under cash basis, only rent received and expenditures paid are taken into account when preparing property accounts.
All expenditure, even capital expenditure, incurred wholly and exclusively for the purposes of the property business is allowed as a deduction from income except capital expenditure incurred on or in connection with:
* lease premiums * the acquisition or disposal of a business, or part of a business * education or training * the provision, alteration or disposal of an asset for use in an ordinary residential property: that is, a dwelling-house that is not used as a furnished holiday letting. If a property is used as both an ordinary residential property and for another purpose, the amount can be apportioned. * non-depreciating assets * the provision, alteration or disposal of land * assets that are not acquired or created for use on a continuing basis in the property business * cars - no deduction is allowed under capital expenditure rules but capital allowances can be claimed * non-qualifying intangible assets and financial assets.
Mileage claim (at approved rates) is available similar to trade unless cost of the vehicle (eg vans) is claimed under capital expenditure rules (or capital allowances for cars).
The restriction applies where the total of the loans is greater than the total value of all properties (the market value of each property when first involved in rental business plus further unclaimed capital expenditure).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.
Then relief for loan and finance costs will be calculated in the same way and be subject to the same restrictions as accrual basis. This includes the restriction for higher rate taxpayers.
There is no requirement to account for the security deposit when it is received. But if any part of it is legally retained by the landlords for unpaid rent or repair costs etc., it will be included in the rental receipts.
Rent-a-room relief is available under cash basis. Rent received under rent-a-room scheme is included to check the exemption limit for cash basis.
The existing ‘replacement of domestic items relief’ will continue to be available for the replacement of these items when the expenditure is paid.
There is no chargeable gain on the disposal of an asset unless:
the asset is land
the asset has never been used in the property business
the capital receipt is not brought into account under cash basis.
The option to use cash basis or GAAP is available to each property business, subject to eligibility and elections.
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.
Transitional adjustments might be required when entering or leaving cash basis to avoid double counting. Examples for transitional adjustment are in PIM1096/ PIM1098
New section 127BA inserted in ITA 2007 to prevent losses from a property business using the cash basis from being set against general income where section 120 would have otherwise allowed this.
It is the tax year 2017/18 that will see these changes being effected along with mortgage interest restrictions. You need to take extra care while preparing property accounts for landlords so they can maximise the benefits available to taxpayers in the legislation.
HMRC Property Income Manual guidance is on PIM1090