Calls to raise threshold on letting spare rooms

The Chancellor should double the tax relief on income made from renting out a spare room when he delivers his pre-Budget report on 9 December, according to the National Landlords Association.

The NLA hopes that Alistair Darling can be persuaded to raise the tax-free "rent-a-room" threshold from its current level of only £4,250 – a level it has remained at since being introduced in 1997.

Since that time, rents have more than doubled in most parts of the country, shrinking the value of the original income threshold. The NLA is one of several organisations supporting the Raise the Roof campaign, which is lobbying for an increase to £9,000 per year.

"The threshold hasn't been increased at all under this Government, and in that time rents have risen considerably. The incentive needs to be in line with inflation," says Matt Hutchinson, a director of flatshare website Spareroom.co.uk, which is also calling on the Chancellor to act.

In Britain, 50 per cent of rented are let for more than £4,250, and in London this figure shoots up to 91 per cent. Although the scheme is often regarded as a useful way to generate an extra income on the side, with average mortgage arrears at £5,525 and the threat of repossession looming, renting out a room has become a necessity for many struggling homeowners.

"Raising the tax-free threshold for live-in landlords would provide an important boost to homeowners who are facing difficulties meeting their mortgage payments," says Chris Norris, the policy manager at the NLA. "For many, the extra rental income really could mean the difference between paying the mortgage and losing their home."

But without a more appealing tax-free incentive, campaigners argue, many homeowners will shy away from the scheme. In particular, the hassle of having to complete a self-assessment tax form sits uneasily with many homeowners, and with the only other option being to reduce rents so that they fall beneath the £4,250 limit, many people simply choose not to bother.

"Tax is one of those issues that can be very intimidating to a lot of people, and the added pressure of self-assessment does put people off," says Mr Hutchinson.

Last year, Ireland increased its rent-a-room relief limit from €7,620 to €10,000 per year. If the British Government follows suit, the rental market is likely to see an influx of live-in landlords looking for a helping hand with mortgage payments or some extra cash on the side. However, while the tax-free benefits are clear, homeowners are warned that there are still pitfalls to watch out for before they dive into the role.

First, it is important to be aware of all the relevant rules and regulations. Crucially, the rent-a-room scheme allows a lodger to rent furnished property only if the landlord uses it as his or her main residence, so any holiday homes and buy-to-let properties are excluded.

A lodger is defined as someone who often shares the rooms of the house. They can occupy just one room, or an entire floor of a property, but homes that have been converted into separate flats do not qualify. If the property is jointly owned with a partner, the tax relief is not doubled. Instead, the relief is simply split and each owner is entitled to earn half of the allowance (up to £2,125) without paying tax.

Another central issue is that the tax-free allowance covers the total income made from a lodger, not just rent payments. Many live-in landlords charge extra for meals and laundry services but this must be added to the total figure. If that takes it over the threshold, the difference is liable for income tax. Landlords who opt in to the scheme will also miss out on the chance to claim for expenses such as new furniture used to kit out the spare room, or wear and tear. Anyone living alone will see their council tax bill shoot up too, as having a lodger affects eligibility for the single person's discount of 25 per cent.

These issues aside, one of the biggest problems can be home contents insurance, a potential minefield for live-in landlords. First, some insurers, such as esure, will simply refuse to offer cover for anyone taking in a lodger. Others, such as Direct Line, will agree to provide cover as long as the lodger is not a student. Many insurers will also offer insurance only on the proviso that as part of the tenancy agreement, potential lodgers have declared that they have no criminal record.

"Premiums won't necessarily rise, but it is vital to give your insurer a ring and let them know the situation before the lodger moves in," says Mark Monteiro, an insurance expert at comparison site uSwitch.com. Renting out a room can affect the terms of the cover, with policies refusing to pay out on claims for damage caused by the lodger. Anyone trying to keep their lodger under the radar by not informing their insurer will risk invalidating their policy all together.

Lodgers also need to take out separate contents cover, as their belongings are not automatically covered by any existing policy the landlord has.

Despite these potential drawbacks, one significant benefit for a live-in landlord is that they have a far more informal and flexible arrangement with a lodger than a buy-to-let landlord has with a tenant. A tenancy agreement should still be in place but merely to outline a few basic details such as rent payments, notice periods and which rooms are to be shared. A lodger has little protection against eviction and a live-in landlord can simply ask them to leave, as long as they give the lodger a "reasonable period of time". In contrast, a tenant must be told in writing to leave, with at least two months' notice.

Above all, it is important to note that the scheme is available to everyone, not just those paying off a mortgage. Renters as well as homeowners can take advantage of the tax-free relief as long as they have checked that the conditions of the lease permit them to take in a lodger. For those who find themselves struggling to meet monthly payments and who are unable or unwilling to move to cheaper accommodation, renting out a spare room can be a financial lifeline.

'A lodger suits me perfectly'

Hannah Mullins, 25, who lives in a three-bed house in Bristol, got a lodger in September. After splitting up with her partner, Hannah, who works for Bristol City Council, was struggling. "I couldn't cover the mortgage payments on my own. Renting out a room was the only way I could keep my house," she says.

She logged on to Spareroom.co.uk to find a lodger and came across Vania Tavares, 26, who was working for an internet mailing business. Hannah charges her £350 per month, including bills, the maximum without exceeding the tax-free threshold. "I've got another spare room so if I could rent that out too I would," says Hannah.

So far, having a lodger has posed no difficulties and her home insurance hasn't gone up. "I've had no problems at all. In fact, we're actually really good friends now and having a lodger suits me perfectly."