Tax status of accommodation businesses

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In terms of taxation, there is a fundamental difference between the way HM Revenue and Customs (HMRC) treats holiday accommodation and residential rental properties.

• Residential rental properties are treated as property investment businesses.
• Hotels, guesthouses and bed and breakfasts are treated as trading businesses.
• Self-catering accommodation can be treated as a trading business, provided that the conditions of the HS253 Furnished holiday lettings (2020) rules are met.

Having your self-catering property treated as a trading business carries the following advantages:

• It ensures that income, net of allowable expenses, is treated as earned income. This means that capital allowances can be claimed in respect of all furniture and equipment used in the business. This compares favourably with the treatment of residential rental properties, where losses can only be offset against future income, you cannot claim capital allowances in respect to any new furniture or equipment, and only part of the interest on mortgage payments can be off-set against income.
• Trading businesses are treated as a business asset for the purposes of determining Capital Gains Tax, which grants you far greater allowances than you receive for residential rental properties.
• For Inheritance Tax purposes, the property is also deemed to be a business asset and can be passed on tax-free.

Note: HMRC has successfully challenged the Inheritance Tax exemption of a self-catering property by arguing the level of service provided to guests was not sufficient for it to be deemed a trading business for the purposes of Inheritance Tax. You should therefore seek professional advice as to whether your property is exempt from Inheritance Tax.

In order for your self-catering property to qualify as a trading business, the following conditions must be met:

1. Commercial operation: the business must be carried on commercially, with a view to making a profit.
2. Pattern of occupation: total periods of longer-term occupation must not exceed 155 days (approximately five months) during the relevant period. A period of longer-term occupation is a letting to the same person for longer than 31 continuous days.
3. Availability: the property must be available for commercial letting as holiday accommodation to the public for at least 210 days (approximately seven months) during the relevant period.
4. Letting: the property must be commercially let as holiday accommodation to members of the public for at least 105 days during the relevant period. For the purposes of this condition, a letting for a period of longer-term occupation is not classed as a letting for holiday accommodation.

The reason for these conditions is to prevent people from trying to gain trade business status and the associated benefits, for either their home or their holiday home, when they have no intention of operating them as a commercially viable bed and breakfast or self-catering operation.

Note: if you operate a self-catering property, you are unable to claim sideways loss relief against other income. Also, regardless of complying with the FHL rules, HMRC may deem your self-catering property to be subject to Capital Gains Tax and Inheritance Tax, if it is determined that you do not provide a sufficient level of service to demonstrate that it is a trading business. It is therefore important to gain advice from an accountant who understands the taxation rules for self-catering businesses.

The removal of the FHL rules will mean that, in terms of tax treatment, self-catering properties will be taxed in the same way as Buy-To-Let properties (as property investments), rather than as trading businesses. This will result in four main changes to the tax treatment of self-catering properties:

• The finance cost restriction rules will apply so that loan interest will be restricted to basic rate for Income Tax;
• Capital allowances rules for new expenditure and allowing replacement of domestic items relief will be removed;
• Reliefs from taxes on chargeable gains for trading business assets will be removed;
• Income from self-catering properties will no longer be deemed relevant UK earnings when calculating pension relief.

Transition rules

However, in abolishing the FHL rules, the following specific transitional rules will apply:

• Where an existing FHL business has an ongoing capital allowances pool of expenditure, they can continue to claim writing-down allowances on that pool. Any new expenditure incurred on or after the operative date must be considered under the property business rules;
• Under current rules, a loss generated from a FHL property business can only be carried forward and utilised against future profits of that same FHL business. After the changes, any profits or losses will be amalgamated with the profits and losses of any other rental property the owner has;
• Losses generated from a FHL business will be permitted to be carried forward and be available for offset against future years’ profits of either the UK or overseas property business as appropriate;
• While roll-over relief, business asset disposal relief, gift relief, relief for loans to traders, and exemptions for disposals by companies with substantial shareholdings will cease, where criteria for relief includes conditions that apply in a future year, these specific rules will not be disturbed where the FHL conditions are satisfied before repeal;
• Where the FHL conditions are satisfied in relation to a business that ceased prior to the commencement date, relief may continue to apply to a disposal that occurs within the normal three-year period following cessation.