Treating tenants’ deposits correctly for tax purposes

It is usual for a landlord to require a deposit from a tenant as security against damage to the property. This cannot be more than five weeks’ rent where the annual rent is less than £50,000 or more than six weeks’ rent where the annual rent is more than £50,000. The landlord can also ask for a holding deposit to reserve the property. This cannot be more than one week’s rent.

How deposits are treated for tax purposes depends on the type of deposit and the basis on which the landlord prepares their accounts.

Security deposits

Security deposits taken by a landlord should be held in a custodial scheme such as those offered by MyDeposits, the Tenancy Protection Scheme, or the Deposit Protection Service. During the term of the tenancy, the deposit continues to belong to the tenant. If there is no damage to the property, the deposit is returned to the tenant at the end of the tenancy. If there is some damage to the property, the landlord may be entitled to all or part of the deposit, with the tenant’s agreement or, where the tenant does not agree, following the resolution of a dispute.

As the landlord is not entitled to the deposit at the point that it is taken from the tenant, it does not need to be taken into account as a receipt of the property income business. However, if at the end of the tenancy, all or part of the deposit is retained by the landlord, under the cash basis the retained deposit is brought into account as a receipt in the period in which the landlord received the cash. If the accruals basis is used, the retained deposit is brought into account as a receipt for the period in which the landlord became entitled to it, even if the cash is not paid over to the landlord until a later date.

Holding deposits

Holding deposits are another form of deposit commonly taken by landlords, particularly in periods where the letting market is buoyant and demand for property is high. As the name suggests, a holding deposit is paid by the tenant to secure the property while the tenancy agreement is signed. In return, the landlord will take the property off the market.

A holding deposit cannot be more than one week’s rent. The terms governing the use of the deposit and the circumstances in which it may be retained by the landlord should be set out in a holding deposit agreement so all parties know where they stand.

Should the let fall through and under the terms of the agreement the landlord retains some or all of the deposit as compensation for the inconvenience and costs incurred about the prospective let, the amount of the retained deposit should be included as income of the property rental business. However, the landlord would be able to claim a deduction for any costs incurred about the aborted let, such as advertising or legal fees.

If the let goes ahead, the holding deposit would either be returned to the tenant or used to form part of the security deposit (see above). If the holding deposit is returned, it does not form part of the income of the business. Where the holding deposit is used as part of the security deposit, the rules set out above governing the treatment of security deposits should be followed.

Partner note: HMRC’s Property Income Manual PIM1052; PIM1094.

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