Landlords are under pressure from the government to grant rent holidays to tenants impacted by the coronavirus pandemic – but how does this affect the tax a landlord pays?
HM Revenue & Customs is quite clear about the tax treatment of debts but so far has given no guidance on the mountain rent arrears pounds that has built up since the tax year started on April 6.
Special rules apply to how landlords deal with these arrears on their tax returns.
- 1 £437m hole in landlord bank accounts
- 2 Bad and doubtful debts explained
- 3 Proving a debt is doubtful
- 4 Accounting for bad debts
- 5 How should landlords treat rent arrears during the coronavirus crisis?
- 6 COVID-19 rent arrears and landlord tax FAQ
£437m hole in landlord bank accounts
More than one in five landlords (22%) told market research firm they had lost rent because of coronavirus.
Of those, tenants had paid less than half the rent due to 19%, while the rest were owed more than half of their expected rents.
Average arrears ranged between £750 and £1,000, which scaled across the private rental sector could mean tenants owe between £328 million and £437 million.
Buy to let mortgage lenders have agreed to offer landlords mortgage holidays, providing tenants can show that they cannot pay rent due to financial problems triggered by coronavirus.
But loans still need repaying and landlords may have to increase mortgage terms or face higher monthly repayments to cover the debt.
Meanwhile, tenants should agree to repay landlords any missed rent.
Bad and doubtful debts explained
Most landlords prepare their accounts on a cash basis, which only covers rent paid, not rent due.
So, a landlord expecting £12,000 rent this tax year but receiving £6,000 paid by the tenant only counts the £6,000 in the bank as income.
The date of receipt is the date a letting agent collects the cash, not the date the money arrives in the landlord’s bank.
The arrears should not be lodged as a bad or doubtful debt if the landlord has a written agreement with the tenant to repay the arrears at an agreed rate.
- A bad debt is when the arrears are clearly not recoverable from the tenant
- A doubtful debt is the amount a landlord expects a tenant to pay after all reasonable steps to recover the arrears are exhausted
Landlords cannot carry a reserve on the balance sheet to cover rent arrears, like a fund of 5% of total rents due for the year.
Neither can rent arrears be written off just because the tenant is a slow payer, or the rent is waived for any reason.
HMRC says in internal guidance for tax inspectors: “A landlord may waive rent (payable in advance) before it is due to them because the tenant can’t afford to keep up the payments originally agreed in the lease. Provided the waiver is effective in revising the terms of the lease, the customer will no longer be able to sue for the rent and, consequently, will no longer be taxable on it.
“If the landlord does not agree to revise the terms of the lease but simply gives the tenant time to pay, they will still be taxable on the rent. But the bad debt rules outlined earlier may apply if there is genuine doubt about the tenant’s ability to pay in the end.”
Proving a debt is doubtful
The key phrase is bad or doubtful debts only become so when ‘reasonable steps’ to recover the money are exhausted.
- A bad debt is when a tenant leaves a rented home and cannot be traced
- A doubtful debt is when a landlord has won a court judgment or eviction order against a tenant in rent arrears.
Doubtful debts escalate to bad debts when it becomes clear the money will never be paid.
Landlords cannot keep a debt on the books and declare the amount bad or doubtful without taking some steps to show they have made some effort to get their money back.
Don’t forget that a bad debt is counted as income in the unlikely circumstances that an errant tenant hands over the money.
Accounting for bad debts
Landlords should hold a bad debt on their balance sheets with the contra in rent receivables.
This removes the debt from taxable income, so a landlord pays no income tax on money that never hit the business bank account.
Government guidance urges tenants to pay their rent and keep to the terms of any rental agreement – and if they can’t, they should discuss their options with their landlord.
Landlords can still issue a notice to start eviction proceedings but should try to agree a payment plan or take the case to mediation before acting rather than go to court.
COVID-19 rent arrears and landlord tax FAQ
The effect of the coronavirus pandemic has had a wide-ranging impact on the economy and landlords are among those in the front line feeling the financial brunt.
The result is a multi-million pound mountain of rent debts, and for many tenants who have lost their jobs, no likelihood of repaying the money.
Here are some of the most asked questions about dealing with rent arrears.
Can I set off rent arrears to reduce my tax bill?
No. Rent arrears can’t be offset if you prepare accounts on a cash basis, only if you draft them on an accruals basis.
Since 2017, all individual landlords should prepare their tax accounts on the cash basis.
What are reasonable steps to tackle bad debts?
Generally, reasonable steps would include:
- Starting possession proceedings in court
- Employing a lawyer or debt collection agency to chase rent arrears
- Keep a log to show a tenant has left without leaving any forwarding address and you have taken steps to try and trace them
No. Although ministers are encouraging landlords and tenant to agree rent holidays if the tenants has financial issues due to coronavirus, HMRC is still maintaining the pre-COVID-19 guidance.
Can tenants get financial help with rent arrears?
Yes. They can try several support options:
- Claiming housing allowance as part of Universal Credit
- In Wales and Scotland, the governments are promising low-interest or tax-free loans to tenants to pay off rent arrears that have grown due to coronavirus
- Agreeing an affordable repayment plan with their landlord. Councils share a £500 million hardship fund in England to help tenants to pay their rent.
Can landlords evict tenants for COVID-19 arrears?
Landlords can start proceedings for rent arrears, but the current rules demand a six month notice period and warn the courts will only hear the most serious cases