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Monday, 18 March 2024 08:58

Abolition of Furnished Holiday Lettings Regime

The government’s Budget announcements on 6th March 2024 included a measure that means the Furnished Holiday Lettings (FHL) tax regime will be abolished from April 2025. The effect of abolishing the rules will be that short-term furnished holiday lets and longer-term residential lets are treated the same for tax purposes and individuals will no longer need to report them as separate income sources.

Under the current regime if you let properties that qualify as FHLs:

  • You can claim Capital Gains Tax (CGT) reliefs for traders (Business Asset rollover relief, relief for gifts of business assets)
  • You are entitled to plant and machinery capital allowances for items such as furniture, equipment and fixtures
  • The profits count as earnings for pension purposes

In practice these can be of considerable advantage. As business assets it meant any gain on a disposal of an FHL property would be subject to the business asset rates of CGT (10%/20%). When this regime is abolished it means gains will be liable at the residential property rates of 18%/24% (reduced from 28% in another measure in this budget) and it will no longer be possible to roll any gains over into other qualifying additions such as another FHL property.

For someone setting up a new FHL under the current capital allowance regime they can claim a 100% deduction for expenditure on furniture, appliances and other equipment and fixtures in the year of purchase. Once the FHL regime is abolished the normal residential property rules will apply which means that they will go onto a renewals basis. That means the initial cost of purchasing these items will no longer attract any tax relief but when an item is replaced in future years with a like for like item 100% of the replacement cost will be deductible at that point. For existing FHL businesses this change won’t have any real effect as they will already have had the tax relief on the initial set up costs but it will impact anyone looking to purchase an additional property to set up for short term holiday lets. The abolition will also mean that tax relief on integral fixtures will no longer be available. Integral fixtures covers items such as electrical wiring and plumbing/sanitary systems.

Tax relief on mortgage and loan interest is available at your highest rate of tax where the interest relates to an FHL business. For residential lettings you can only obtain tax relief at the basic 20% rate on interest and finance charges so the abolition will result in a reduction in tax relief on finance costs.

Residential letting income does not qualify as earnings for pension purposes. This could mean some individuals are limited in their capacity to make personal pension contributions in future as there is an annual limit of the lower of £60,000 or 100% of relevant earnings.

If you incur losses in an FHL business those losses can only be used to set against other FHL profits. Residential losses likewise can only be set against future residential losses so in some respects combining both into one residential property rental regime could be an advantage.

Although regarded as business assets for CGT purposes FHL properties do not currently qualify for Business Property Relief for Inheritance Tax purposes so abolition of the FHL regime will not have an impact on IHT except that it will reduce estate planning opportunities as once the regime is abolished it will no longer be possible to pass on FHL properties during your lifetime and claim business assets holdover relief to avoid a crystallisation of a capital gains tax charge. If you gift residential property to a connected person (e.g. your children) it is treated as a sale at market value for tax purposes and as a result likely to be chargeable to CGT. That is even more of an issue now that the annual CGT exemption is reducing again to just £3,000 from 6th April 2024. 

HMRC have not yet released the detail of what the abolition of the FHL regime will mean but there are other less obvious repercussions that we will need to watch out for:

  • At present FHL properties come within the Business Rates regime so many small operators will pay no rates at all if they qualify for the small business rates relief. The logical conclusion to FHL abolition is that these properties will become liable to Council Tax which will mean an increase in costs
  • FHL is a VATable supply so if this was being carried out by someone already registered for VAT (e.g. as part of a farm diversification) they would have to account for output VAT on the lettings income. If the FHL income alone was in excess of the £85,000 VAT registration threshold (uplifted to £90,000 in the latest budget) the operator would have had to be VAT registered and account for output VAT on the income. Residential lettings are exempt from VAT so presumably  from April 2025 output VAT will no longer be charged but at the same time it will not be possible to recover input VAT on any related expenditure. The net effect could work in some operators favour but others could be worse off particularly if they are incurring significant expenditure on conversion or renovation of properties to be used for short term letting. Some operators may want to consider bringing holiday letting activities under the umbrella of their main VAT registered business in future to take advantage of the partial exemption rules which might enable them to recover at least some of the ‘exempt’ input VAT.
  • Residential lettings income is apportioned according to the underlying ownership of the property with an assumed default of equal shares unless HMRC is specifically notified of a different share. That may be very different to how the profits of an existing FHL business are being apportioned where the profit share is more likely to accrue to the person(s) doing the day-to-day running of the business who may not necessarily be the owner of the property itself.

To qualify as FHL a property has to be available for letting for at least 210 days and actually let for at least 105 days in a given tax year with no lets of more than 31 days included in these totals. That meant anyone looking to offer longer term winter lets to cover quiet periods could potentially jeopardise the FHL qualifications. Following abolition of the FHL regime operators will no longer have to worry about failing the qualifying tests if they have lets in excess of 31 days which may give them more flexibility.

These budget changes have been brought in to try and stem the number of properties being lost from the residential letting market and turned over to short term holiday accommodation. Whilst the abolition of the FHL regime will certainly mean some of the tax advantages are being lost it will continue to be the case that the typical weekly or monthly rental income from holidays lets is still significantly higher than would be achieved from a longer term residential let. In the more popular vacation areas it is unlikely that these changes will have much effect on the supply of longer term letting properties as holiday lets will still provide a better return on investment but in areas of the country that achieve lower numbers of weeks let there may be a switch back to longer letting especially as there will be a lot less active management required of the properties.

Last modified on Monday, 18 March 2024 09:51


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