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When renting out a property it is usual to take a deposit from the tenant to cover the cost of any damage 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.
It is important than the landlord understands how this should be treated for tax purposes.
Tenancy deposit scheme
Where a landlord takes a deposit from a tenant to cover damages, the deposit must be placed in a tenancy deposit scheme (TDS) approved by the government. In England and Wales, the deposit must be registered with the Deposit Protection Service, MyDeposits or the Tenancy Deposit Scheme. Separate schemes apply in Scotland and Northern Ireland. The deposit that may be taken 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.
At the end of the tenancy, the landlord must give the tenant the deposit back within ten days of agreeing how much is to be returned. Where the tenant disagrees with the amount that the landlord wishes to retain, disputes can be resolved by the TDS used by the landlord as long as both parties agree.
Treatment of security deposits
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. These may exceed the deposit recovered.
Holding deposits
A holding deposit may be taken by the landlord in return for taking the property off the market while the necessary paperwork is undertaken. Unlike a security deposit, a holding deposit does not need to be placed in a TDS. 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 their costs. The deposit retained is included as income of the property rental business. However, corresponding costs, such as those incurred in 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 business and as such is simply ignored for tax purposes. However, the landlord can deduct any associated costs.
If the holding deposit is retained by the landlord as a rental payment, it is included as rental income in calculating the landlord's taxable profit.
If the holding deposit is retained as part of the security deposit, the rules as set out above in relation to security deposits apply.
Partner note: ITTOIA 2005, Pt. 3; HMRC's Property Income Manual PIM1094.