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Treating Deposits from Tenants Correctly for Tax Purposes

A landlord will normally take a deposit from a tenant when letting a property to cover the cost of any damage caused to the property by the tenant. A deposit of this nature may be referred to as a security deposit, a damage deposit or a rental deposit. The landlord may also ask for a holding deposit in return for taking the property off the market while the necessary paperwork is undertaken.

 

Security Deposits

The purpose of the deposit is to cover items such as damage to the property that extends beyond normal wear and tear. The deposit may be used for cleaning costs if the property was not left clean and tidy, replacing broken items, etc. It may also be used to recover unpaid rent.

The deposit that may be required from a tenant is capped at five weeks’ rent where annual rent is less than £50,000 and at six weeks’ rent where annual rent is more than £50,000.

Deposits taken by a landlord or agent for an assured shorthold tenancy in England or Wales are protected by Government authorised schemes. The various schemes each feature an alternative dispute resolution service, removing the need to go to court in the event of a dispute.

In a straightforward case, the landlord will hold the deposit for the duration of the tenancy and, if there is no damage for the tenant to pay for, the landlord will return the deposit to the tenant. In this situation, the deposit does not form part of the income of the property rental business, and is not taken into account in working out the taxable profit.

If there is damage to the property or the furniture, or if the property has not been cleaned in accordance with the tenancy agreement, the landlord may wish to retain some of the deposit to cover these costs. The landlord cannot simply keep the money – the amount retained must be agreed with the tenant. If agreement is not reached, the dispute will go to arbitration. It should be noted that the burden of proof falls on the landlord, who should provide evidence to support their claim to retain all or part of the deposit.

In the event that some or all of the security deposit is retained by the landlord, the amount retained should be included as income of the property rental business. However, any costs incurred by the landlord can be deducted in working out the taxable profit.

 

Holding Deposits

A landlord may take a holding deposit from the tenant, particularly when the rental market is buoyant. The tenant pays the deposit in return for the landlord holding the property for them while the paperwork is completed. The holding deposit cannot be more than one week’s rent.

If the agreement falls through, the landlord may retain some or all of the holding deposit to cover his costs. The deposit retained is included as income of the property rental business. However, corresponding costs, such as drawing up the agreement or undertaking viewings, can be deducted as expenses.

If the deposit is returned to the tenant, it is not treated as income of the property.

If the let goes ahead, the deposit may be returned to the tenant, in which case there are no tax implications; treated as a payment on account of rent, in which case it is included as rental income of the business; or used as part of the security deposit, the tax implications of which are set out above.

 

Partner note: ITTOIA, Pt. 3; HMRC’s Property Income Manual PIM1094.

 

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