The rent-a-room scheme allows both owner occupiers and tenants to let out a room or rooms in their only or main home and receive rental income of up to £4,250 a year tax-free. For example, the scheme can be used by parents to raise funds to pay for their student son or daughter’s university accommodation by renting out their room while they are away.
Under the rent-a-room scheme, profits made on renting a room in your house are tax free as long as gross receipts do not exceed £4,250 per tax year. The gross receipts figure of £4,250 applies before taking account of any expenses, but includes amount that are paid by the lodger for the provision of any meals, or services such as cleaning and laundry.
Participation in the scheme is not compulsory and instead profits and losses can be computed in the normal way. This would be beneficial, for example, if expenses exceeded rental income such that there was a loss, as opting out of the scheme will allow for the possibility of obtaining relief for that loss.
The rent-a-room limit of £4,250 applies per tax year. If someone else receives income from letting accommodation in the same property, the tax-free limit is halved to £2,125 per year. However, the limit remains at £2,125 per person if three or more people let accommodation in the same property, such that it is possible to receive rental income of more than £4,250 per property tax-free.
The limits are not reduced for periods of less than 12 months and apply regardless of whether you take in a lodger for one month or for 12. This is handy if you only want a lodger, say, during term time.
Operating the scheme
If gross receipts are less than £4,250 (or £2,125 where accommodation let jointly), and you want to take advantage of the exemption, it is simply a case of entering the words `rent a room’ in the appropriate place on the self-employment pages of the self-assessment return. This is box 1 on the short self-employment pages (SA103S). Boxes 2 to 7 should be completed as appropriate and `£4,250’ or ‘£2,125’, as appropriate, should be entered in box 19. If there are any capital allowances balancing charges to take into account these should be entered in box 25.
Bill’s son leaves home to go to university. To help meet the costs of his son’s university accommodation, Bill rents out his room for 32 weeks a year at £100 per week. Bill therefore receives rental receipts of £3,200 a year. As this is less than the rent-a-room exemption limit, Bill can opt for rent-a-room relief to apply and receive the rental income tax-free.
Letting as a trade
In some instances, letting a room or two in your own home may amount to a trade, for example, where you run a bed and breakfast business or guest house or where meals and other substantial services, such as laundry and cleaning. The fact that you may be deemed to be trading does not mean that you cannot benefit from the rent-a-room exemption.
However, where this is the case, profits from the trade must not be taken into account in working out the profits of any property rental business that you operate. For example, if a person ran a bed and breakfast business from their home and rented out houses to students, the income from the bed and breakfast business would be trading income and the rental income from letting out the houses would be income of a separate property rental business.
As regards the bed and breakfast business, if gross receipts were less than the rent-a-room limit of £4,250 (or £2,125 where accommodation let jointly), rent-a-room relief can be claimed in the usual way.
Receipts exceed rent-a-room limit
In the event that gross receipts from letting accommodation in your own home exceed the rent-a-room limit, there are two routes which can be taken to work out the amount on which tax should be paid. The default is to work out the profit or loss in the normal way, by deducting expenses from rents received. This method (method A) will apply automatically unless you tell HMRC that you would prefer to use method B. Method B is simpler, in that tax is paid on the gross amounts of receipts less the rent-a-room exemption limit (£4,250 where provided by a single person, £2,125 where provided by two more people). Monies paid for the provision of related services, such as meals or cleaning are taken into account in working out the gross receipts.
As the taxpayer is able is to select whether to use method A or method B, it makes sense to perform the calculation using each method and choose the one that gives the best result.
After her daughter leaves home to go to university, Caroline decides to rent out her room during term time to provide herself with some additional income. The room is let to a lodger for 30 weeks a year at £150 per week, which includes cleaning and meals.
Caroline incurs expenses of £2,525 a year on providing meals, cleaning, light and heat etc.
Her total rental income is £4,500 (£150 x 30 weeks).
Under method A, her taxable profit is £1,975 (£4,500 - £2,525).
Under method B, her taxable profit is £250 (£4,500 - £4,250)
In this case Method B is clearly preferable and Caroline should opt for this method to be used.
Where the taxpayer wishes method B to apply rather than method A, they must tell HMRC no later than 31 January following that after the end of the tax year in question. Therefore, for 2011/12 the election to use method B must be made by 31 January 2014.
Once an election for method B has been made, it is possible to revert back to method A if that proves more beneficially the following year. Again, HMRC must be told that the taxpayer no longer wishes method B to apply within the timescale set out above.
Where expenses exceed rental income and receipts exceed the rent-a-room limit, method A will always be preferable. Where receipts are less than the rent-a-room limit, it will be beneficial to opt for the rent-a-room scheme not to apply. This will ensure that relief can be given for the losses.
Where losses are brought forward, they can be set against any taxable profit from the rent-a-room letting, regardless of how those profits are calculated. To the extent that they cannot be utilised, they can be carried forward for offset against any future profits.
Before rushing to take advantage of the scheme, if the property is mortgaged, it is advisable to check with the lender whether they have any objections to you taking in a lodger. Likewise, if your home is rented, you should check your lease to make sure that you are allowed to take in lodgers. It is also advisable to review your insurance cover to check that it is adequate and check with your insurer that there are no problems with having a lodger.
Practical Tip – Remember - you can receive rental income of up to £4,250 a year tax-free from letting a room in your own home.