Rent a Room scheme – how it works and tax rules

If you’re looking for ways to improve your bank balance, one option is to rent out your spare room. By signing up to the Rent a Room scheme, not only do you enjoy the extra income from the rent, but also up to £7,500 a year is free from tax.

Who’s eligible for the Rent a Room scheme?

The Rent a Room scheme is an optional scheme that’s open to owner occupiers or tenants who let out furnished accommodation to a lodger in their main home.

It allows you to earn up to £7,500 a year tax-free, or £3,750 if you are letting jointly.

You don’t have to be a homeowner to take advantage of the scheme. If you’re renting you can also lease out a room to a lodger, as long as your own lease allows you to do so.

Opting in or out of the scheme

If the amount you earn from renting out the room is less than the thresholds of the Rent a Room scheme, then your tax exemption is automatic and you don’t need to do anything.

If you earn more than the threshold, you must complete a tax return (even if you don’t normally). You can then do one of the following:

• choose to opt into the scheme – in which case you need to let HM Revenue Customs know this on your tax return and claim your tax-free allowance
• not opt into it – in which case you simply record your income and any associated expenses on the property pages of your tax return

To ask to be sent a tax return if you don’t normally receive one, contact HM Revenue Customs using the link below.

There’s no special form for telling HM Revenue Customs that you don’t want to be part of the scheme. If you earn more than the threshold or already complete a tax return you simply declare the relevant lettings income and expenses when completing your tax return.

Providing meals and services

You may wish to charge for additional services when you take in a lodger, such as providing meals or laundry services.

The money you receive for these services must be added to the rent you receive to work out your total income. If your total income is more than £7,500 for the tax year (6 April to 5 April), and your overall income is greater than the individual Personal Allowance, you will need to pay some tax.

If you need to pay tax

If your income from your lodger is more than £7,500 for the tax year, you have two options:

1. Pay tax on your actual profit from the property (which is calculated as income received minus allowable expenses). This is the normal arrangement for a rental business.
2. Pay tax on the gross (before tax) income minus the tax-free threshold, but with no allowance for expenses.

The simplest way to work out what to do is to calculate what your expenses are. If they are larger than the tax-free threshold of £7,500, then you will be better off with the first option. If they are smaller than the threshold, then go with option two.

You don’t have to stick with a single method each year. You can change year to year, so long as you inform HM Revenue Customs.

Running a business

If you run a guest house, bed and breakfast or provide services such as catering and cleaning as part of a letting business, you can still take part in the Rent a Room scheme.

Advantages and disadvantages of the Rent a Room scheme

The biggest advantage of the scheme is that you can earn £7,500 a year absolutely tax-free.

However, that advantage may be outweighed for some people by the fact that you cannot claim any expenses related to the letting.

So if you have to spend money repairing wear and tear in the property or replacing a broken boiler, you won’t be able to deduct any of that expense against income if you let out your property under the Rent a Room scheme.

You’ll need to work out for yourself whether you will be better off in or out of the Rent a Room scheme.

An example

Frank lets out the spare room in the home he owns for a rent of £200 a week. That gives him an annual income of £10,400 – which is more than the Rent a Room allowance.

If he stays in the Rent a Room scheme, he will be taxed at his top rate of tax on the income above £7,500. So if he is a basic rate taxpayer that means paying 20% tax on £2,900 (£10,400-£7,500). This would result in a tax bill of £580.

However, he could opt out of the scheme and treat his income as a normal rental income. This means he can deduct expenses and only his final profit is taxed.

Over the year Frank’s expenses come to £2,000. Once that is deducted from his total rent, it leaves him with a profit of £8,400. However, his tax bill will have nearly doubled to £1,680 (20% of £8,400).

In this example Frank is better off in the Rent a Room scheme. However, if his expenses were higher – say, £4,500 – he would be better off opting out of the scheme.

The importance of keeping records

It’s important to keep records of your income and expenses. Even though you cannot claim expenses with the Rent a Room scheme, you may need those records should you opt out later on.

Before you take a lodger in

There are a number of checks you need to perform before taking in a lodger. If you are the owner of the property and have a mortgage, you will need to check with your mortgage lender to make sure you are allowed to rent out a room under the terms of your mortgage contract. You will also need to check with your home insurer that it is allowed under their terms.

If you are renting, you need to ensure that your lease allows you to take on a lodger.

Speak to your lender, insurer or landlord to ensure you can take part in the scheme .

Other ways to boost your income

The Rent a Room scheme is just one way you can bring some money in.

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