Capital vs revenue expenditure in the context of properties

Article written by Daniela Moss and Rutvik Patel, Menzies. 

The distinction between capital and revenue expenditure for tax purposes can be difficult to make. It is a grey area and something that HMRC enquire into on a regular basis.

The purpose of this article is not to definitively identify whether the expenditure would be considered capital or revenue but instead to provide some sound guidance to assist you in making the decision.

As always, if you are unsure then we recommend that you consult a tax advisor.

Tax relief for revenue expenditure is given in the tax year that it is incurred. Revenue expenses are deducted from rental income which reduces the annual rental profit reported on an individual’s Self Assessment tax return each year.

Tax relief on capital expenditure is given on the eventual disposal of the property. Any capital expenditure incurred reduces the overall gain or increases the loss on disposal.

The most common expenses treated as allowable revenue expenditure that can be deducted from rental income are:

• Letting agent and/or management fees;
• Ground rents, service charges, water rates, council tax, gas, electricity;
• Insurance – building insurance, landlord policies;
• Professional fees;
• Cost of services – wages of gardeners and cleaners or other property-related services;
• Direct costs – phone calls, advertising for new tenants;
• Vehicle running costs – proportion used for rental business only;
• Mortgage – relief is available for the interest element only and given as an income tax reducer at the basic rate of 20%;
• Relief can be claimed for the cost of replacing domestic items, including furniture, furnishings, household appliances and kitchenware)

General maintenance and repairs – not improvements or anything that can be seen as an enhancement on the market value of the property. A few examples of this include replacing roof tiles, fixing a broken boiler, redecoration between tenancies or repairing water/gas leaks.

Alterations due to advancements in technology are treated as revenue expenditure if the functionality and character of the asset is broadly the same. For example, replacing single glazing with double glazing.

If the total expenses do not exceed £1,000, consideration should be given as to whether it would be beneficial to claim the property allowance of £1,000 instead of the actual expenses incurred. Please refer to our “Rental Income” article for further detail regarding the property allowance.

When selling a property you can deduct “enhancement (improvement) expenditure” in calculating the resulting gain or loss on the sale.

It is important to note that in cases where individuals undertake repairs or replacements using modern materials, it may at first appear to be an improvement because of greater durability and superior quality, but in most cases it will remain to be a revenue expenditure.

For example, the following would be revenue expenditure:

• Replacing wooden beams with steel girders, and
• Replacing lead pipes with copper or plastic pipes.

1. Enhancing the value of the asset

It should be noted that “enhancing the value of the asset” looks at the purpose of the expenditure and not whether there is an actual enhancement to its value.

The most common example of an improvement of this nature would be adding an extra room to the property. This includes a kitchen extension or a loft conversion. It should be noted that painting or decorating would ordinarily be considered revenue expenditure, but when it is in relation to a kitchen extension or a loft conversion, it would likely be considered part of the capital cost.

Improvement expenses would also include improving or upgrading part of the asset. This could include upgrading a kitchen or bathroom with a higher specification.

As noted above replacing roof tiles would be considered revenue in nature, but the replacement of an entire roof would likely be seen as a capital expenditure due to it increasing the value of the property.

2. Reflected in state or nature of asset at time of disposal

Expenditure which has wasted away or been demolished before the disposal does not qualify as enhancement expenditure because it is not reflected in the state or nature of the asset at the date of disposal, which determines the value of the asset at disposal.

Examples of this include:

• constructing a building on a piece of land where, at the time of disposal, the building has been demolished and the land has reverted to its original state.
• where a tennis court was constructed but later demolished to make way for a swimming pool. In this case, the cost of constructing the swimming pool would be capital, not the cost of the tennis court.

Enhancement Expenditure in the period before newly-acquired property is let:

If a property is acquired in a dilapidated condition, expenditure incurred in repairing it and putting it into a fit state for letting, including expenditure on decorations may not be considered revenue in nature and accordingly cannot be deducted when calculating the rental profits. However, such expenditures can be deducted for capital gains purposes.

HMRC’s guidance states that the underlying principle is that the cost of buying a property in a good condition is capital expenditure, and hence the cost of buying a dilapidated property and putting it in a good condition is also capital expenditure. This is because the cost of acquiring a property in a dilapidated state is likely to be less than if it were in a good condition.

Regardless of whether expenditure incurred is classed as revenue or capital, it is important that you keep sufficient records should HMRC challenge the position later.

It is a statutory requirement to keep your records for at least 5 years after the 31 January tax return deadline for each tax return.