As a landlord, you’ll likely take a deposit from your tenants to protect against potential damage to your property. But did you know that how you treat these deposits for tax purposes depends on the type of deposit and the accounting method you use?
Here’s a breakdown of the key points you need to know to ensure you handle tenants’ deposits correctly when it comes to tax.
Security Deposits: What You Need to Know
A security deposit is a standard requirement for most landlords, serving as protection against property damage. The amount you can request is capped:
- Five weeks’ rent if the annual rent is under £50,000
- Six weeks’ rent if the annual rent is over £50,000
Landlords must hold the security deposit in a custodial scheme, such as MyDeposits, the Tenancy Protection Scheme, or the Deposit Protection Service. While the tenancy is ongoing, the deposit belongs to the tenant, and it is returned to them at the end of the tenancy—provided there’s no damage to the property.
If some or all of the deposit is retained due to damage, the tax treatment depends on how you prepare your accounts:
- Cash basis: The retained deposit is treated as income in the period when the landlord physically receives the money.
- Accruals basis: The deposit is treated as income in the period when the landlord becomes entitled to it, even if the money hasn’t been paid over yet.
Until you retain all or part of the deposit, you don’t need to account for it as part of your property income business.
Holding Deposits: Reserving the Property
A holding deposit is taken to reserve a property while the tenancy agreement is finalised. The landlord will remove the property from the market in exchange for the deposit.
A holding deposit can’t be more than one week’s rent, and its purpose should be clearly outlined in a holding deposit agreement so that both parties know the conditions under which it may be retained.
For tax purposes:
- If the tenancy doesn’t go ahead and the landlord keeps some or all of the holding deposit as compensation for time and costs, that retained deposit is treated as income for the property rental business. The landlord can also claim deductions for costs incurred, like advertising or legal fees.
- If the tenancy does proceed, the holding deposit is either returned to the tenant or used to form part of the security deposit. In both cases, it doesn’t count as income for the business.
If the holding deposit is used as part of the security deposit, you should follow the tax rules for security deposits.
Need Help with Your Property Business Tax?
Treating tenants’ deposits correctly can make a difference when it comes to tax time. If you want to make sure you’re handling them right, or you’re unsure which accounting method to use, get in touch with Jon and the team. We can help you get it right and avoid any tax issues with your property business.
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