Rent A Room Scheme – How It Works and Tax Rules

What is Rent A Room scheme?

The Rent a Room Scheme: Suppose you're in an abundance of rooms in your house with no one else to occupy them in the near future. You want to rent them out to earn that extra cash, but you don't do so as you don't want to go through the hassle of registering as a landlord or filing out an additional return at the end of the year. To help such people, there is a way to let out those extra rooms by opting the ‘Rent A Room’ scheme.

If you let out a room or number of rooms, you're entitled to rent a room relief. This means that you're exempted from the tax you earn by way of renting out, if it falls below the certain threshold. There are many eligibility conditions and things to consider before you opt for this scheme.

To make this hassle free and to make sure you get maximum benefit out there would be many questions in your head like:

1. How much tax free income would you receive?
2. What are eligibility requirements?
3. How to opt in or opt out of the scheme and when to do that?
4. What if you want to run it as a business?
5. What are taxation rules for the scheme?
6. What are the advantages or disadvantages of the scheme?

Given below is the answer to all your questions Andrew other things to keep in mind while opting for Rent A Room Scheme:

How much tax free income can you get?

Rent a room scheme allows you to earn up to a threshold of £7,500 per year on letting out furnished rooms. This means that any income crossing the threshold limit would be taxable. If you're sharing this revenue with your partner, then you will be taxed only on your share of rent income received.

Eligibility Criteria for Rent A Room Scheme

First of all, this scheme is optional and not mandatory to opt. You can always rent out through other ways if that is more befitting to you. Second, to opt for ‘Rent a Room’ scheme, you need to be living in the house whose room you're letting out. If you have more than one house, the room you're letting out should be of your primary residence.

You can use Rent a room scheme if:

a. You're letting out a furnished room

b. If you're letting out, room business also amounts to trade. For example, if you're running a guest house or bed and breakfast business, and you provide services like meals and cleaning, etc.

Also, you don't need to be the home owner to take advantage of Rent a Rooms scheme. You can let out rooms even if you're staying on the lease as as long as your lease allows you to do that.

When are you not eligible for Rent a Room scheme?

1. If the room that you're letting out is not the part of your main house.
2. It is not furnished.
3. If the room acts as an office for any business.
4. It is your home, but you're not staying there.

How to opt in or opt out of Rent-A-Room scheme?

Opting in - The tax exemption is an automatic process if the the amount you earned by renting out is within the threshold limit. You don't need to fill out additional forms for opting this scheme. However, if you're earning a rent above the threshold limit, then you need to file a tax return, even if you weren't doing it normally. For opting under the scheme, all you have to do is let HM Revenue & Customs know about this in your return and you can then claim your tax exemption.

Opting out - There is no special way of informing HM Revenue & Customs. If you're earning rent income and you declare the relevant income and expenses on your completed tax return, then you'll be taxed in that manner.

What if you want to run it as a business?

Say you're running a business of providing bed and breakfast, and you want to opt into this scheme, you can also do so. You might provide services like laundry services, provide meals or any other personalized services, such additional income by way of these services over and above the renting the room will also be included in the threshold limit of £7,500.

For example, say your total income is more than the limit of £7,500 for the year 2017-18, and also your overall income is also greater than your individual personal allowance, then in such case, you might need to pay some tax.

What are taxation rules for Rent-A-Room scheme?

If your income is more than the threshold limit of £7,500 for the tax year, you have two options for paying tax:

A. Pay as per the normal arrangement for your rental business. That is basically paying tax on your actual profit you derived by reducing your allowable expenses from your income received.

B. Another way is to pay tax by reducing your tax free threshold from your gross income before tax. But there would be no allowable expenses.

How to decide which option to choose?

The easiest way is to calculate your total expenses and check whether they are more than your threshold limit of £7,500. If they are then opt for the first option, if not then you better go with the second option.

It is not necessary that if you follow one way of paying tax you have to follow that every year. You can change from one way to other for paying by most effective tax form. You can change year to year as long as you inform HM Revenue & Customs about the change in your tax return.

What are the advantages or disadvantages of the scheme?

The most important advantage of opting Rent a Room scheme is that you get to earn £7,500 a year absolutely tax-free. But this advantage also comes with a negative effect that you cannot claim the expenses related to renting out the room.

So if you're spending money on refurbishing the room due to wear and tear or replacing some broken boiler or something, then the expense incurred on that cannot be claimed while filing your return under this scheme. In such a case you have to work out yourself whether this scheme would be profitable to you or not.

Keep your records up to date

It is very important to maintain a separate record and files for income and expenses incurred specifically for this scheme of Rent a Room. Even though you cannot claim back the expenses, it might be helpful later when you decide to opt out of the scheme.

Other things to keep in mind:

Before letting out make sure you are allowed to so do as per your lease agreement. Also check the background of the person to whose you're letting out the room if you're doing it for a long term. Maintain a proper record of personal details of the people you're letting out the room for future reference in case of any complications.

Example:

Below is the example to make you understand the Rent a Room scheme in an easy manner.

Suppose, Ms. Sara is renting out a spare room in her home that she owns at a rent of £200 a week. Now her annual income is £10,400 which is more than the threshold limit of £7,500.

Now if she decides to stay in the scheme, then he will be taxed at the highest rate on the income over and above £7,500. That means she will be paying 20% tax on £2,900 which would be £580.

However, if now she wants to opt out of this scheme and treat his income as normal income, she can do so by claiming the expenses and then calculating her actual profit on which she would be taxed.

If suppose over the year Ms. Sara's expenses are of £2,000 in total. Deducting that from the total rent income, she would incur a profit of £8,400. Taxing on it at 20% would nearly double her tax, i.e., £1,680 (20% of £8,400).

From above we can say that Ms. Sara is better off if she opts for Rent a Room scheme.

Now if suppose her total expense is £4,500 or even higher than that. In such a case she would be better off to pay tax as per normal taxation rules and not as per Rent a Room scheme. This is because the tax as per the scheme would be more than the tax as per normal taxation rules because in the normal arrangement you get to claim your expenses which you incurred on your rooms which are rented out.

By above example along with the above-mentioned points now it might clear out the Rent a Room scheme for you. For any more clarifications, you can check HM Revenue & Customs website.

To conclude we can say that the Rent a Room scheme is a very beneficial scheme for people who are below the threshold limit and such people can enjoy the tax free income.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.