Tax changes for furnished holiday lets

If you have a holiday home, changes announced in the Spring 2024 Budget mean you may want to take action before 5 April 2025. The draft legislation for these changes was published on 29 July 2024 and provided some clarity on transitional relief and anti-avoidance. It also confirms that the beneficial tax treatment for Furnished Holiday lettings (FHLs) regime will be abolished from 6 April 2025 for income tax and capital gains tax (1 April 2025 for corporation tax).

One of the Budget giveaways was to reduce the top capital gains tax (CGT) rate on the sale of residential property to 24%, down from 28%, whether the CGT rate will be increased remains to be seen.

Changes to the taxation of FHLs

The FHL regime treats qualifying residential short-term lettings as a trade for certain tax purposes. Once the regime is abolished, owners will lose the following tax benefits:

Mortgage Interest

Mortgage interest on FHLs is currently treated as a deduction from rental income for income tax purposes. From April 2025, relief will instead be given as a 20% tax credit so for higher and additional rate taxpayers. This means a reduction in tax relief for individuals from 40% and 45% respectively.

Capital Gains Tax on FHLS

Capital Gains Tax on disposal of FHLs may currently qualify for Business Asset Disposal Relief (BADR), where the first £1m of lifetime gains are taxed at 10%. Alternatively, the gain can be ‘rolled over’ on purchases of certain new business assets. From April 2025, the normal residential property CGT tax rate, currently of 24%, will apply and the ‘rollover’ of gains will no longer be possible.

However, anti-forestalling provisions have been introduced such that where there is an exchange of contracts on a disposal from 6 March 2024 but which completes after 5 April 2025 (1 April 2025 for companies), claims to rollover relief and holdover relief will be denied where the transfers are between connected persons. There seems to be an exemption for third party transfers undertaken for wholly commercial reasons, but this will require disclosure

Allowable Expenses for FHLs

FHL businesses are currently eligible for capital allowances. From April 2025, you will only be able to claim a deduction for the cost of replacing domestic items against your rents. Any existing capital allowances pools will be carried forward and you will be able to continue to claim writing-down allowances on that pool.

FHLs & Pension Contributions

Tax relief for pension contributions is limited to the higher of £3,600 or 100% of net ‘relevant earnings’. From April 2025, FHL profits will no longer be treated as relevant earnings.

Losses

Carry forward losses from FHLs will be able to be offset against future profits of the property rental business generally (rather than just profits from the former FHL property).

Corporation tax

Income and expenses for corporation tax will need to be apportioned on a time basis, subject to just and reasonable override.

The substantial shareholdings exemption (SSE) for subsidiaries is blocked for disposals from 1 April 2025. So, disposals of corporate vehicles that would have qualified if made in the previous two years need to happen before that if SSE is desired. As with the changes for BADR and rollover relief considered above, this will also be subject to anti-forestalling provisions where a contract for disposal is exchanged from 6 March 2024 but which completes on or after 1 April 2025.

I own an FHL. What action should I take?

Do you usually let out your holiday home sufficiently to satisfy the criteria for an FHL ie. let 105 days out of 210 days available for letting? If so, then you have some decisions to take. If the current arrangements suit you, there may be no need to change but it is still sensible to check how much extra tax you may have to pay. If you are not sure, you should seek to understand the financial impact of the various changes in tax rules on FHLs and consider the two options discussed below.

One option is to sell the property. Although the sale may qualify for BADR (so taxed at 10%) and, even if it doesn’t, the headline rate of tax is also now reduced to 24%, the annual gains exemption has also reduced which might increase the final tax payable - so seek advice on your likely tax charge before you exchange on the transaction. Remember that capital gains on property need to be reported, and the tax paid, within 60 days of completion.

Alternatively, it might be the right time to pass on the property to your family. Giving an asset to a ‘connected relative’ is treated as a disposal at market value. However, as an FHL property is a business asset, it may be possible to elect to ‘holdover’ any capital gain on disposal to relatives. Of course, if they subsequently sold it, CGT would be payable at 24% on any historic gains. In addition, the gift may have Inheritance Tax implications, particularly if you continue to use the property without paying rent, so consider your options carefully.

If your holiday home does not qualify as an FHL, there is no pressing need to act but, if you were considering a sale, the 4% reduction in CGT may mean it is a good time to sell.