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Creating a home office and how it affects your tax

With home working becoming so widespread, we are often asked what are the tax implications and pitfalls of building a home office. In most cases this is an office in the garden, as this is usually far cheaper and a more practical way of creating space than building an extension or converting a loft.

It should be noted that the tax treatment will be different for those who are self employed compared to those who are limited companies and this article considers both.

Tax Relief on building and running a business from home   

The structure and buildings allowance, introduced in 2018, allows businesses to claim 3% on qualifying expenditure for the construction, renovation, conversion of buildings and structures.

However, the allowance strictly prohibits any tax relief on residential property. This includes: any other building or structure that functions as a dwelling; any structure located in the grounds of a residence: or the purchase of land. So to use this allowance you would need to buy or take on a lease for the piece of land where the structure is to be built and this could incur Stamp Duty Land Tax issues.

As a garden office or outbuilding is normally considered a structure it is therefore not possible to claim tax relief on the building cost, including all charges for any planning foundation work and installation. Even if the garden office is moveable, it will still count as a structure from which your business operates rather than an item of equipment.

However running costs, such as the cost of heating, lighting and broadband to the office, are tax deductible. On a practical note, it is unlikely that you will open a separate energy account just for operating your business from your outbuilding, so you will need to make a fair estimation of your bills to allocate as a business expenditure. Water rates are allowable if the supply of water is separately metered from your home. Repairs and redecoration costs are also tax-deductible.

It is also usually possible to claim tax relief by way of capital allowances on some fixtures and fittings, such as those specifically required for work purposes.  Examples of these are office furniture, shelving and equipment.

The cost of installing power, including electrical wiring, light fittings and heating, also qualify through the plant and machinery (P&M) allowance. So too does WIFI cabling, CCTV and thermal insulation, despite being part of the initial construction. The P&M allowance does not apply to anything that is not owned outright by the business, so if you hire any equipment this cannot be claimed for.

It is usual to claim capital allowances by way of Annual Investment Allowance (AIA) which enables a business to claim 100% of the cost of the asset in the first year, subject to the annual limit.  A measure to temporarily increase the AIA limit from £200,000 to £1m for qualifying plant and machinery incurred during the period from 1 January 2022 to 31 March 2023 was announced in the Autumn Budget 2021. It should be noted here that structures and buildings do not qualify for AIA so it is not possible to get capital allowances for the office costs.

A further measure introduced to help companies to recover from the pandemic is the super-deduction for capital expenditure incurred between 1 April 2021 and 31 March 2023. Companies can claim the allowance by writing off 130% of qualifying costs for new and unused assets such as fire alarms, bathroom sanitary ware, carpets, computers and office furniture.  If disposing of these assets before 1 April 2023 the proceeds are taxed at 130% of the amount received.

What about VAT?

If your business is VAT-registered it is possible to recover some costs by reclaiming VAT incurred on the cost of the building structure or furniture, and ongoing running costs, if it is solely used for business purposes. This option is not available if you pay for the garden office personally. Similarly, VAT cannot be reclaimed if you are a director of a company and using the accommodation for personal use. So if you use the room for both business and private use, only the business proportion of VAT can be reclaimed.

For businesses who use the VAT flat rate scheme you will need to ensure the cost of the materials and the cost of the construction are separate. Also, under the scheme only capital assets for individual purchases at a minimum of £2,000 can be reclaimed so materials should be brought all together and charged as a single transaction. 

Personal tax implications

If the building is used exclusively for business and you are a company, you will not have a personal tax liability. Any personal use could result in restrictions to the allowances you’re able to claim. Furthermore, if you paid for your garden office through your company and intend to use it privately by yourself or other family members, it is likely this will trigger a benefit in kind and both personal income tax and national insurance contributions would be payable. As it can be difficult to prove no or minimal use to HMRC there is a risk of a benefit-in-kind tax charge.

One other consideration is capital gains tax (CGT). When you sell your home, you are entitled to a tax exemption called Principal Private Residence Relief (PPR). This means you don’t usually have to pay CGT on any gains made from the sale of your only or main residence. If the garden office has been used for personal use this will not attract CGT. However, it will apply if the office has been exclusively for business. This means that when the property is sold, you will need to apportion the gain on a just and reasonable basis.

Whether or not CGT will apply will also be dependent on the type of office you have constructed. If the office is a structure than can be uninstalled and moved to another location, there will be no CGT. But it is a more permanently installed structure and will be sold along with the main residence, a separate valuation on the building alone may be sufficient to show if there has been an increase in its value. If a gain does arise it may be covered by your CGT exemption. It is worth pointing out here that a bricks and mortar structure will devalue at a much slower pace than a converted wooden shed.

Corporation tax implications for company directors   

If your building is a proper bricks and mortar building, when you eventually sell your house part of the proceeds are allocated to the garden office and belong to the company. The proceeds less the original capital cost are subject to corporation tax for the company. Any of the fixtures and fittings that have had capital allowances claimed and if sold at a value will create a balancing charge and corporation tax may be due.

Interest could be claimed on the funds introduced to the company to pay the build costs. This will save corporation tax at 19% but may have an impact on your personal tax depending upon what rate of tax you pay and if you can use the savings allowance. Any interest paid by the company is net of basic rate tax and the company will need to complete a CT61 to declare this and pay over any tax due.

Are business rates due?

It is not usual but you may also be liable to pay business rates on your new structure so it is worth checking with your local council’s valuation office before building commences.

If business rates do apply, you should be able to alleviate the cost of these with the small business rates relief. This is available for property with a rateable value of £15,000 or less. For property with a rateable value between £12,001 and £15,000 there will be a gradual percentage reduction. Business rates do not apply to properties with a rateable value under £12,000. If business rates do apply, CGT will be chargeable on the sale of the property.

Last but not least

Further issues for consideration include your insurance and mortgage, if you have one. As such you should notify your insurance company of your intentions and must inform you mortgage lender. Planning permission may also be required so you should contact your local authority for their advice.

Need further advice?

If you have any questions or would like to discuss your plans with us, please let us know. Getting professional advice will help ensure you make the right decisions and maximum benefit from the tax saving opportunities available to you.

28/10/2021