With effect from 6 April 2016, the amount of relief available under the rent-a-room scheme has increased to £7,500 (from £4,250) and this increase could potentially benefit a greater number of individuals who receive rental income from a lodger or lodgers in their own home.

The rent-a-room scheme was first introduced by the Government in the 1990s to encourage individuals to take in lodgers by offering them favourable income tax treatment on the rental income received.

Ordinarily, any rental income received by an individual is taxable income for them and may then need to be reported on a Tax Return and may give rise to an income tax liability.

The rent-a-room scheme means that the rental income received from a lodger (up to the prescribed limit) can be exempt from income tax. As mentioned above, the limit is now £7,500 so if the total amount of rent received in the tax year (before deducting any expenses that the individual has incurred in providing the accommodation) is £7,500 or less, the whole of the income is exempt from tax. It is worth noting that this limit will be halved if another person is also entitled to the income e.g. if a husband and wife own their home jointly and receive rent from a lodger, the limit is halved to £3,750 each (even if the income is not split equally between them).

If you don’t complete a Tax Return, and the rent you receive is less than the threshold, then the tax exemption is automatic and you don’t need to do anything.

However if you are already required to complete a Tax Return for other reasons then UK property pages should be completed, and the exemption claimed, if you receive income from letting rooms in your home, even if it is below the rent-a-room exempt amount.

There are various conditions that must be met in order to qualify for the rent-a-room scheme and these can be summarised as follows:

  • The accommodation being provided must be furnished
  • The residence must be in the UK
  • The residence must be the individual’s only or main residence for at least part of the tax year
  • The relief cannot be applied to rooms let exclusively for business purposes e.g. as an office (although lodgers can carry out incidental work activities if they are students or occasionally work from home etc.)
  • The accommodation provided to the lodger must be ‘part of’ the residence and not completely separate to the residence.

It is important to note that the rent-a-room scheme is optional. If using the ‘normal’ principles for working out the profit/loss made on any rental income gives a preferable result, then an individual can elect to use this approach instead. This is probably best explained by way of a couple of examples.

Let’s assume that Janet receives rental income from a lodger of £400 per month (£4,800 per annum) and incurs costs of £2,000 per annum in providing that accommodation (e.g. increased heat and light costs, council tax, insurance etc.). As the ‘gross rents’ of £4,800 are less than £7,500, the total £4,800 received is exempt from income tax under the rent-a-room scheme so Janet would be wise to use the rent-a-room relief for the 2016/17 tax year (in this situation it would apply automatically, assuming Janet does not complete a Tax Return, as the gross rents are less than the limit).

If on the other hand, her annual costs of providing the accommodation were £5,000, Janet would probably be better to not use the rent-a-room relief as she has in fact incurred a loss of £200 in renting out part of her residence so if she completes a Tax Return and claims that loss, it can be carried forward and set against any future rental income received from the same property business.

It is also worth pointing out that 2016/17 would be the first year that Janet’s rental income is fully covered by the rent-a-room scheme (since the limit was £4,250 previously).

Let’s now consider John who receives rental income of £700 per month (£8,400 per annum) from his lodger in his central London residence. With the new limit of £7,500, John would almost certainly be better to claim the rent-a-room relief which would leave him with £900 of taxable rental income. It would only be beneficial for him to use the ‘normal’ principles of calculating the rental profit/loss if the actual expenses he incurred in providing the accommodation exceeded £7,500 for the year.

You can change between claiming rent-a-room or paying tax on your actual profits (i.e. receipts less expenses) from year to year.

Where the property is subsequently sold and you have been letting a room then the amount of private residence relief should not be affected by taking in a lodger. However if you have taken in more than one lodger at a time or otherwise let out all or part of your home then you may have capital gains tax to pay when the property is sold.

The above is for general guidance only and no action should be taken without obtaining specific advice.