UPDATE: As announced in the Summer Budget 2015, as of April 2016 the rent-a-room scheme allowance will increase to £7,500. This is the first increase to this allowance in 18 years.
If you provide furnished accommodation in your main home you may qualify for tax-free rental income under the Rent-a-Room Scheme. If you receive £4,250 or less per year for the accommodation then you will not need to pay tax on the income.
If you receive £4,250 each year but there are 2 of you that own the property, the income will be split between you and also the allowance will be split so you will each be able to receive a maximum of £2,125 tax free.
This allowance most commonly applies to people who have a lodger in their main home or who run a Guest House or Bed & Breakfast from their home. You may not claim it if the room is not part of your main home and the room must be furnished. You cannot claim it if the room is in your UK home while you live abroad or if you let the whole of your home out and not just a part. You also cannot claim it if the room is used as an office or for business purposes although it is fine if your lodger works from your home in the evenings.
To calculate your income for the year, you must not only include the rental income, but also any amounts you receive for meals, goods and services such as cleaning or laundry. If your total income is less than £4,250 you pay no tax on the income but if it is higher than £4,250 you can choose how to treat it for tax purposes.
Your first option is to treat it as you would any other source of income by calculating the expenses you have incurred and deducting those from the income to arrive at a ‘net profit’ figure. This figure will be entered on your tax return and taxed at your marginal rate (e.g. 20% if your total income falls into the basic rate band and 40% if your total income falls into the higher rate band).
Alternatively, you may find that it is better to take the rental income for the year and deduct the £4,250 allowance. This figure is then entered on your tax return as rental income and taxed in the normal way. You cannot deduct any of your expenses if you use this method, but you may find that the overall income that is taxed is lower than using the standard method.
You can change the method you use each year, depending on which is most tax-efficient.
If your income less your expenses results in a net loss rather than a profit then it is best to use the standard method. This loss can be carried forward and offset against future rental profits, even if you choose to change your method in the next year.
For example, if you receive income of £5,000 from renting your room to a lodger, but incur expenses against that of £6,000 then you will have an overall loss to report on your tax return of £1,000. The following year, you may again receive £5,000 but only have £1,000 expenses to offset against this. Your net profit is therefore £4,000. It would be better in this case to use the second method and offset the £4,250 allowance against your £5,000 income so you only need to report £750 (£5,000 less £4,250) as your net profit. You have a loss of £1,000 brought forward from the previous year which you can offset against this £750 so your actual net profit will be £Nil and you will still have £250 losses to carry forward to the following year.
If you have any queries about the Rent-a-Room scheme or if you are not sure which method to use to calculate your net profit, please don’t hesitate to contact us on 01872 271655 or email Lydia.firstname.lastname@example.org