Rent-a-room scheme: Behind the headlines

The rent-a-room scheme was introduced in 1992 to relieve the housing crisis in the UK by allowing beneficial tax calculations for property owners (or indeed tenants) receiving income from allowing lodgers to use furnished accommodation inside the taxpayer’s main residence.

The legislation is set out in ITTOIA 2005, ss 784-802.

Benefits of the rent-a-room scheme

1. Gross income from lodger is under £7,500

The scheme enables these taxpayers freedom from reporting anything to HMRC. The rent-a-room scheme applies without the requirement for any claim or election for these landlords, and up to £7,500 costs are automatically deducted as expenses; meaning there is no profit to tax, and no tax to pay. This is irrespective of the level of the actual expenses incurred by the landlord.

Example 1: No tax to pay

Jordan was a marketing director earning £170,000 a year. In her UK property business, she let out a two-bedroomed flat in Winchester at a profit of £30,000 a year, and a furnished room in her own three-bedroomed Southampton home. She earned £120 gross rental income a week from the room, and the costs associated with letting the room were £800 in the tax year 2020/21.

Jordan’s gross rental income from the room was £6,240, and even though her expenses were only £800 (meaning that in reality she made a taxable profit of £5,440, which at her income tax rate of 45% would have resulted in income tax of £2,448), due to the fact that the rent-a-room scheme applies automatically to those with gross rental income from a furnished room up to £7,500, her expenses will be deemed to be £6,240; as such, she has no profit and no tax to pay.

There is an option to disclaim the automatic rent-a-room scheme. This option would normally only be chosen if the taxpayer incurred a loss which they wished to offset against some other current or future taxable UK property income.

Example 2: Claiming for actual costs

Rather than having costs of £800 in the year, Jordan (see Example 1) needed to fully redecorate and damp proof the room in the tax year, and her costs were in total £8,540. As Jordan has made a loss, she decides to disclaim the automatic rent-a-room relief.

As a result, she has a loss of £2,300, which she may instead chose to offset against the £30,000 other UK property income in the year, saving her £1,035 in tax at her 45% rate.

2. Gross income from lodger is over £7,500

These landlords may either offset the actual costs associated with the furnished room or a standard offset of £7,500. Where costs incurred are less than £7,500, an immediate tax saving of £7,500 less the actual costs incurred is made at the individual’s personal tax rate.

In addition, an administrative hassle is removed. Calculating the lodger’s share of the total light, heat, gas, water, Wi-Fi, council tax and other such joint expenses is a laborious and often difficult task.

Example 3: The £7,500 standard offset

Joshua was a London Underground tube driver earning £55,000 a year. He let out a furnished room in his Leytonstone four-bedroomed London home. He earned £300 gross rental income a week. The costs associated with letting the room were £2,500 in the year 2020/21.

Joshua’s gross rental income was £15,600, and as expenses were £2,500, he would have made a taxable profit of £13,100 on which, at his income tax rate of 40%, he would have income tax due of £5,240.

However, because the rent-a-room scheme applies a £7,500 standard offset, rather than the actual expenses, his profit will reduce to £5,600. He will therefore only need to pay tax of £2,240, saving tax of £3,000.

Details the headlines don’t tell you…

1. Per property

The £7,500 limit is not available per bedroom or per person living in the house; it is per property. In theory therefore, there is a maximum of £7,500 costs deductible, whether there is one lodger or several in the property.

However, where there is more than one landlord or tenant letting out a furnished room, the allowance is halved. This is not so interesting if it is couple sharing the benefit, as they will still reach £7,500 by having £3,750 each. But this amount is not further decreased the more landlords there are (see HMRC’s Property Income manual at PIM4010).

Example 4: Three landlords

Maisy, Molly and Maude are triplets who own a six-bedroomed home in Bristol. Each triplet lives in one room and lets out one of the other rooms under the rent-a-room scheme.

Between them they are able to have £11,250 rental profits (£3,750 each) covered by the scheme, despite having only one property.

Note: the landlord will not obtain another £7,500 if they move to a new property during the year. The £7,500 will cover all the properties that the landlord has in succession in one tax year.

2. Use for other purposes

The furnished room is eligible for relief only if the lodger is using it as a living space. The relief is not available if the room is let as an office or for other business use such as a storeroom or dark room or workroom.

However, a student lodger studying in the room, or a businessperson answering emails in the evening, would not be enough to render the room ’for business purposes’.

3. More than one main residence

The property needs to be the individual’s main residence (on the facts), so it is unavailable for more than one property per couple.

However, it does not necessarily need to be the same main residence that the individual or couple elects to be their ‘main residence’ for capital gains tax principal private residence (PPR) purposes.

Example 5: Two residences, one lodger

A couple have a London apartment and a Norwich house. They use the London apartment most of the time. If the lodger was in the London apartment they would be able to use the rent-a-room scheme as this is their main residence on the facts. HMRC describe this as “where friends and correspondents would expect to find [them]”.

If they had selected their Norwich house as their main residence for PPR purposes, this would not affect their eligibility for the rent-a-room on the London property. If, however, the lodger was in the Norwich house, HMRC would “look very critically” on such a claim.

4. Main residence relief

Usually, if a taxpayer lets out part of their residence, a CGT charge applies to the period or the part of the home that is not being used as the main residence. This charge will potentially still apply if the owner is using rent-a-room relief.

However, there is some relief in HMRC’s statement of practice SP 14/80, which states that if the lodger is “living as a member of the owner’s family and taking meals with them” then the main residence of the taxpayer is not restricted for CGT purposes. This is, however, restricted to one lodger.

Practical tip

Be careful with on the rent-a-room scheme if you are claiming means tested benefits, as any rent received from a lodger will count as income and may reduce your benefits.

This article originally appeared