Are you getting the most from rent-a-room relief?
If you let part of your home, rent-a-room relief might automatically exempt the rent from tax. This sounds good but it might not be tax efficient. When might the relief not work to your advantage and what steps can you take to counter this?
Rent-a-room relief
Rent-a-room relief (RARR) was introduced in the 1990s to simplify the tax reporting requirements (and reduce HMRC’s admin) for individuals who let part of their home. It achieves this by exempting rental income up to a limit (£7,500 for 2021/22). Where income exceeds the limit there’s no automatic exemption but the £7,500 can instead be claimed as a deduction from the rent received instead of the actual costs of letting.
Example – part 1. Joan owns and lives in a three-bedroom property in a university town. She takes in two students as lodgers. Each has exclusive use of one bedroom and use of the kitchen and living areas of the property. Joan charges each lodger £400 per month (£9,600 per year). This exceeds the RARR limit and therefore the income is not exempt. However, rather than fuss with calculating the proportion of expenses, which Joan reckons would only amount to around £2,500, she can elect to deduct the RARR amount of £7,500 so that she only has to pay tax on £2,100.
Exempt income
For one year Joan only takes in one lodger so she can renovate the other room and made general repairs to the shared areas. As a result her expenses exceed rent meaning she’s made a loss. The trouble is, as the rent fell below the RARR limit it’s automatically exempt from tax and the loss is ignored for tax purposes. If the exemption did not apply Joan could use the loss to reduce tax on the rent for later years, say when she has two lodgers again.
Tip. You can disapply RARR so that a loss will not be lost because of the exemption. This requires a special election which stays in force until you revoke.
Example – part 2. Joan made the election prevent the RARR exemption applying for year of the loss, which amounts to £3,000. The following year Joan takes in two lodgers, again at £400 per month. Her income is back to £9,600 and her expenses are £2,500. She therefore revokes her claim for RARR not to apply so that she can claim the £7,500 as a tax deduction. This leaves £2,100 taxable. The good news is Joan can use the loss of £3,000 to reduce the taxable amount to nil and carry forward the remaining £900 of loss to reduce the taxable amount for the next year or, if it’s not needed, later years.
Key points. Part 2 of our example shows that:
the tax loss is only achieved by Joan making the election to disapply RARR for the year
to the benefit from the tax deduction in the following year Joan must revoke the election and claim the RARR amount as a deduction in place of her actual letting costs
the loss can be used to reduce the taxable amount for a later year even where the RARR amount is claimed as a deduction; and none of the loss issued in a year where the rent is exempt because it’s less than the RARR amount. For example, had Joan not taken on a second lodger the year following the renovation, her rental income would have been £4,800 and so exempt. The loss would not be needed and would be saved for use against profits of a later year.
Rent-a-room relief is disadvantageous in a year when your letting expenses exceed rental income. In this situation you should elect to disapply the relief. This allows the loss to be carried forward and used to reduce tax on rental income for a later year, even if the rent-a-room deduction is claimed.