For 40 years, taxpayers have been able to reap the rewards of a beneficial tax regime for Furnished Holiday Lets (FHLs). The rules have undergone several changes throughout these four decades but have always been favourable compared to a residential property for let; a differential that has only been exacerbated by recent governments’ stances on taxation of residential landlords.
However, all of that is due to come to an end in 2025 as announced in the Spring Budget earlier this year. These changes will affect the operator of the traditional holiday cottage, as well as the more recent rise of the Airbnb. Whether the second home is let out on a part-time basis, or as part of a vastly diverse property portfolio, these changes are likely to have a significant impact on those taxpayers running these businesses.
Before we look at the benefits for FHL landlords, it is worth a quick reminder of who is going to be affected here. To qualify as an FHL for tax purposes, the property must first meet the following conditions:
As always, there are a number of clarifications and exceptions to the above, but that should give a reasonable overview of the properties we are considering here.
So now we’ve identified our qualifying properties, what tax advantages are we getting?
Firstly, there are several differences to how relief is obtained for business expenses compared to a residential letting property. Loan interest is one of the starker differences, whereby a buy-to-let landlord taking a loan to purchase their property will always be restricted to basic rate tax relief. This means that, even if they are taxed at the 40% or 45% income tax rate on their property income, their tax relief on the loan interest will always be restricted to 20%. An FHL landlord, however, will get full relief for their loan interest at their effective rate of tax, meaning double or more of the tax relief for the same expenditure on the same property, just based on how it is used.
Another big difference between the two is the availability of capital allowances. These allowances allow tax relief for expenditure for items used in the business that have an enduring benefit. For a residential landlord, relief is only available on the replacement of domestic items within the property, so extremely limited. For an FHL landlord, however, they can claim against the fixtures and furnishings within the property. Not only is this more tax relief on your expenditure, but also means a big boost to tax relief in year one when the property is first furnished, meaning expenditure will be high while the income is yet to start flowing.
FHL income is also treated as relevant earnings when considering pension contributions, whereas residential letting income is not. This therefore provides an added opportunity to shield some of the tax liability not covered by loan interest deductions or capital allowances as above and diversify the strategy for retirement for these property owners.
Finally, FHLs are treated as business property for capital gains tax purposes. This has a number of benefits, not least of which is the headline rate of capital gains tax that applies. This is because residential property comes with a surcharge compared to non-residential property, meaning a basic rate taxpayer will pay tax at 18% rather than 10% on any profits on disposal, and a higher or additional rate taxpayer will pay 24% rather than 20%.
There are also a number of important reliefs available to owners of business property, such as the ability to “rollover” the gain from one business asset into another, or gift the asset and defer any tax charge until the asset is finally sold. It should also be noted that Business Asset Disposal Relief may be available on FHL disposals, bringing the rate down to 10% irrespective of tax bracket, increasing that tax saving to 14% for higher and additional rate taxpayers up to their first £1million of qualifying lifetime gains.
From 6 April 2025, all of this disappears, and FHLs will be treated the same as any other residential property letting business.
On the plus side, this will lead to an element of simplification. There will be no need to refer to the furnished status or occupancy conditions for tax purposes, and the records can be pooled with any other letting activities as part of one rental business.
Unfortunately, that is probably where the good news ends, and even that positive slant might be somewhat tempered by the looming approach of Making Tax Digital in 2026, requiring taxpayers to submit quarterly electronic records to HMRC.
One of the highest priorities to consider for those already running FHL businesses will be continued viability. Some taxpayers will suddenly find that they are only now receiving a fraction of the tax relief on their loan interest that they were before, and their capital allowances cease as well. If the business was barely getting by before, this additional tax burden could make the operation more trouble than it is worth, or not viable at all given the ongoing requirement to introduce capital without the tax relief.
This is where strong collaboration between financial advisers and accountants will be key in accurately determining the tax position of these businesses and translating this into realistic cashflows so clients can plan accordingly.
Another consideration for advisers and landlords alike will be the impact upon relevant earnings. With no change in circumstances, some individuals’ retirement provision plans may be in serious jeopardy. It is certainly not the case that previous plans can be relied upon, and new pension provision strategies should be considered for anyone with FHLs in their portfolio.
One point to bear in mind is that this change is a removal of a simplified system of reliefs, but not a bar on these properties qualifying as trades in their own right. Many will operate their holiday let portfolios in a highly commercial fashion that may qualify as a trade-in any case. After all, there are many similarities with such businesses and that of a hotel or holiday park where trading status would rarely be in question, opening up all of the same reliefs above (and more!). If that is a possibility, the importance of professional advice cannot be stressed enough here. This is a highly subjective area and HMRC are likely to take a strong stance on such claims; just look at the string of inheritance tax cases on holiday lets to see how many of these trading cases are refused. Even so, for truly trading enterprises, this possibility should not be discounted.
So, what options do we have if we know we have FHLs in a portfolio that will no longer qualify for beneficial treatment?
One of the first considerations must be to consider if the property sits in the right place. With the reliefs available for the next half a year or so, there is still the possibility to tax-efficiently move properties around the family while deferring a resulting tax liability until an actual sale. This will not be suitable for everyone, and advice is always needed in considering such transfers, but there is a closing window of opportunity here that can still be used.
If the properties are in the right place, and about to fall within an overall letting portfolio, another consideration should be incorporating the rental business into a limited company. The gradual penalisation of residential landlords through the taxation system over recent years has encouraged many landlords to consider moving their property portfolios into a company. This can allow the benefit of a full deduction for loan interest, as well as opening up more possibilities for pension contributions through the company.
If done correctly, this may be achievable tax-free, however, incorporating a property portfolio is not a project to be undertaken on the cheap. The price of sound advice to ensure this is correctly planned and implemented will far outweigh the tax cost if it is not done right.
Another serious consideration at this point should be whether the property still serves the best purpose within the portfolio, or whether now is the time to sell. As always, tax should not be the only driving factor behind any decisions, but if the commerciality of the venture was on a knife edge before these changes tip it the other way, then now may be the time to sell up and invest the proceeds in something more fit for purpose. Certainly, if landlords are considering selling their FHLs anyway, it is likely to be better to sell up in February and potentially secure a 10% rate, rather than waiting until April when it could be 24%.
As with any change in circumstances, the changes in tax legislation applying to FHLs will necessitate a review of the financial plan in place.
There is a chance to put some of these matters on the right path now, while the beneficial rules are still in place, but those with significant FHL businesses will need to carefully consider their ongoing strategy ahead of 2025 and give serious thought to alternative ways to structure their assets.
The above is all based on the changes we know about, but with a new government and a budget in October with a deficit to fill, it may be all-change again before the end of the year, so make sure you’re clear on your objectives and get the right advice in place early on.
This article originally appeared on FT Adviser.
This article does not constitute financial advice and is provided for informational purposes only.
