Letting a room out to a lodger is a great way to earn some extra cash, and done correctly, it can be tax-free with the rent-a-room scheme.
Here’s how the tax-free allowance works, how to claim it and what happens once you go over it.
How Does the Rent a Room Scheme Work?
The scheme lets you earn up to £7,500 tax-free from letting a furnished room in your own home.
You are eligible for the allowance every tax year, although the amount may change so you should check the HMRC website for changes.
A tax year runs from 6 April to 5 April.
If you share your home with your partner then your allowance is halved to £3,750.
Who Can Use the Scheme?
You can use the scheme and claim rent a room relief on your income if you:
- let a furnished room to a lodger
- run a guest house or bed and breakfast
- rent or own your home
Who Cannot Use the Scheme?
You can’t claim rent a room relief if you rent out a space that is:
- not part of your main home;
- used as an office or for any business
- part of your UK home and is let while you are living abroad
Calculating Gross Rental Income for Rent-a-Room Relief
Your gross rental income must not exceed £7,500 during a tax year to qualify for the allowance.
Gross rental income means the total of:
- all rental income before expenses
- any amounts paid for meals, goods and services eg: cleaning or laundry
How to Claim the Rent-a-Room Allowance
If you have gross receipts of less than £7,500 then you are automatically entitled to the allowance.
That means you do not need to let HMRC know or submit a tax return to claim it unless you complete a return for another reason.
What to Do If You Exceed the £7,500 Threshold
If your gross rental receipts go over the tax-free allowance, then you’ll need to let HMRC know about it and start to complete a self-assessment tax return.
When you complete your tax return, you’ll be able to choose how you want to calculate tax on the extra amount you have earned.
If you complete your return online, then HMRC will automatically calculate your tax for you.
HMRC give you two options to choose from to work out how much tax you have to pay. You can choose the one that is most beneficial to you.
You pay tax on your actual profits – that means on the difference between gross rental receipts less any allowable expenses.
You pay tax on any gross receipts over the rent-a-room allowance, but you don’t deduct any expenses.
HMRC automatically assume you that you use Method A. If you want to use Method B, you’ll need to let HMRC each time you complete your tax return.
How Much Tax Will You Pay?
The amount of tax you pay on your rental income will depend on:
- Your total income during the tax year;
- Whether you choose Method A or Method B.
The current tax rates are:
|Basic rate 20%||£12,501 to £50,000||£11,851 to £46,350|
|Higher rate 40%||£50,001 and £150,000||£46,351 to £150,000|
|Additional rate 45%||over £150,000||over £150,000|
Karan rents our a room to a lodger in her own home and has a part-time job which pays her £20,000 per year.
She charges the lodger £10,000 for tax year 2019/2020 and has expenses of £9,000.
Karan will pay tax on her rental profits of £1,000 (£10,000 less £9,000). Her total income is £21,000 and her total tax bill is £1,700 worked out as follows:
£12,500 x 0% = £0
£8,500 x 20% = £1,700
Karan will get credit for any tax deducted by her employer on her payslips.
Karan will pay tax on gross rental income above the tax-free amount of £7,500, without deducting any expenses of £2,500 (£10,000 less £7,500).
Her total income is £22,500 and her tax bill will be:
£12,500 x 0% = £0
£10,000 x 20% = £2,000
Again Karan will get credit for any tax deducted by her employer on her payslips.
Method A or Method B?
In the example above, Karan is better off choosing Method A because she reduces her taxable income by deducting for expenses.
But everyone’s situation is different.
Generally speaking, if your expenses are less than the rent a room allowance of £7,500 you will probably pay less tax under Method B.
But under method B you can’t create a tax loss.
If you are new to renting out a room and have incurred costs but have gross rental income of less than £7,500, then it could be worthwhile completing a tax return using method A.
That way you can then record your loss in the current year as you can use it against future profits to save tax in later years.
How to Register with HMRC
If you need to complete a tax return, then you’ll need to sign up with HMRC. The easiest way to do this is to sign up online.
Once you have completed the online form you’ll be registered for self-assessment and you will:
- Be sent a UTR number, which a 10 digit code;
- Need to complete a self-assessment tax return form by 31 January each year declaring your income in the UK Land & Property section (see below);
- Pay any tax due by 31 January each year (along with payments on account by 31 January and 31 July each year).
Can I Switch Between Method A and Method B?
You can choose whether you want to use A or B each time you complete your tax return. That way you can pick the one that saves you the most tax.
What Happens If I Move House During the Tax Year?
If you move house during the year, you’ll need to add up your gross rental receipts and expenses if you’re claiming them.
You are only entitled to the £7,500 allowance once per year, not per house.
What are the Changes to Rent-a-Room Relief from 2019
The rent-a-room allowance was introduced to help individuals earn some extra cash and ease housing problems.
With the advent of Airbnb, HMRC felt that hosts were exploiting the tax rules for the purposes of making money.
From April 2019 the rent-a-room scheme rules have changed and require that the property owner must be living in the accommodation for at least part of the time that the room is let out.
Is Airbnb Covered by the Rent-A-Room Scheme?
Although the use of rent-a-room by Airbnb Hosts is under scrutiny by the government, yes currently you can use the relief against a short-term rental.
You’ll need to make sure that it meets the criteria of being a furnished letting and be present for at least part of the time the lodger is in the property.
How Do I Claim Rent-a-Room Relief on my Tax Return?
Your gross rental receipts need to be included in the property section of your tax return form.
There are three entries that need to be made:
1. Put an ‘X’ in box 4 to indicate to HMRC that you intend to claim for Rent a Room:
2. Enter Income collected from renting out the room.
3. Enter your claim for Rent a Room Relief in Box 37. This cancels out the income entry you made and means no tax charge will be made.
Updated 23 August 2019
Anita is a Chartered Accountant with over a decade of experience taking self employed business owners from financially confused to business savvy.
She is the creator of the ‘Go Self Employed’ website, which her corner on the internet where she makes self employment less terrifying.