As the cost-of-living crisis continues to bite, the idea of earning tax-free income is appealing. If you have a spare room, you can make this a reality by letting it out and taking advantage of the rent-a-room scheme.

What is rent-a-room?

The rent-a-room scheme allows you to earn up to £7,500 tax free each tax year by renting out one or more rooms in your own home. If the income is shared between two or more people, each can earn up to £3,750 tax free each year.

To qualify, the let room must be in your main home and it must be let furnished. You can also benefit from the scheme if you run a guest house or bed and breakfast business.

Nature of exemption

If your gross rental receipts are not more than your rent-a-room limit (£7,500 or £3,750 depending on whether one or more people receive the income), you do not need to tell HMRC about the income or pay tax on it. Your gross rental receipts are the money that you receive from letting the room before deducting any expenses.

If your gross rental receipts are more than your rent-a-room limit, you can still choose to use the scheme and deduct your rent-a-room limit rather than your actual expenses to arrive at your rental profit if this is more beneficial. This will be the case if your actual expenses are less than your rent-a-room limit.

Example

Kelly has two spare rooms in her home which she lets furnished to lodgers for £100 a week. Her rental income from each room is £5,200 a year – a total from both rooms of £10,400. She incurs expenses of £2,000 in the tax year.

As Kelly’s gross rental receipts are more than her rent-a-room limit of £7,500, her income is not exempt.

If she calculates her profit in the usual way by deducting her actual expenses from her gross rental receipts, her taxable profit will be £8,400.

However, if she opts to deduct the rent-a-room limit instead of her actual expenses, her taxable profit will only be £2,900 (£10,400 – £7,500). This is clearly preferable.

Choosing your method

If your gross rental receipts are more than your rent-a-room limit, you will need to complete a Self Assessment tax return. HMRC will automatically calculate your profits in the usual way by deducting your actual expenses from your rental income (Method A) unless you tell them otherwise. If you want to deduct the rent-a-room limit instead (Method B), you will need make the deduction in box 37 of the UK property pages of your Self Assessment tax return.

You can switch between the methods as necessary to achieve the best result.

Losses

If you make a loss, and your gross rental receipts are below the rent-a-room limit, you may wish to instead calculate the loss in the normal way rather than claiming rent-a-room relief so that the loss is available to set against any future profits. In this situation you must complete a tax return without claiming rent-a-room relief.