Much has been said of commercial tenants demanding rent holidays, but what about the thousands of residential landlords with just one or two properties to let? These landlords have been hit with a raft of changes in recent years, the dearest being the withdrawal of full relief for mortgage interest, leaving finance costs only relievable at the basic rate of 20 per cent. This move alone has reduced profits for many landlords as they bear part of the costs out of taxed profits.
Residential landlords may be tempted to assist their tenants by offering a rent holiday or rent deferral, especially where their tenants have been furloughed. A rent holiday occurs when the landlord agrees to forego rent for a particular period, whereas under deferral, the rent will be paid at some later date.
If rental income receipts are £150,000 or less, then the annual rental profit is calculated by reference to the rent and expenses received and paid. This is known as the cash basis. But for professional landlords with buy-to-let portfolios where the receipts are in excess of £150,000, or for those that operate through a company, the rules are different.
Rent holidays and deferrals have tax consequences. Landlords must account for their rental and expenses under normal accountancy principles. Income is recognised according to the amount which is earned in the year from the use of the property, rather than the amount actually received.
In the case of a rent holiday, the general rule is that it is spread evenly over the period of the lease. For example, a year’s rent holiday is given on a lease for five years where the market value rent is £20,000 per annum. So, instead of total rent being £100,000 over the five years, it is £80,000. In this case, the annual rent for tax purposes is £16,000. The same principle applies when a rent holiday is given mid-lease, with the holiday being spread over the remaining lease period.
So, if the lease period extends over the current tax year, the value of the holiday will need to be spread over the remaining lease period. In other words, landlords will not get full relief for the rent holiday this tax year, unless the lease ends before 6 April 2021.
In respect of a rent deferral, it’s different. The annual rent remains due, even if it might be received in a later tax year. The annual rent must still be brought into account for tax purposes, even if not all that rent has been paid in the period. This could mean that the landlord is taxed on rents that have not been paid, because a legitimate rent deferral has been agreed.
If the tenant is subsequently unable to pay the deferred rent in the future, which could be the case if they have become redundant, the deferral will need to be shown as a bad debt. This will result in it becoming a deductible expense. For a debt to be bad, it must be estimated to be uncollectable, rather than merely unpaid. The bad debt rules also apply to tenants that just don’t pay.
So, a rent deferral is the better option if the tenant can ultimately pay the rent. A rent holiday might be better if the tenant is suffering a short-term blip in finances. Of course, which option is better at the outset, is up to that crystal ball.