Making Tax Digital for Income Tax means keeping digital records and sending updates through compatible software. For landlords and sole traders doing their own bookkeeping, an important question remains: are the transactions being recorded correctly?
A tenant deposit retained for damage, a transfer to your personal account and a builder’s invoice can all appear in your bank feed. Each needs different treatment.
Two recent examples show why understanding the transaction and setting up your software properly matter.
How to record a tenant deposit retained for damage
A landlord using Hammock to manage his own MTD records had a question.
His tenants had just moved out and left damage to the property. He expected to spend at least £3,000 putting it right. However, only £150 from the protected tenancy deposit was awarded to him.
His question was simple: where should he record the £150?
It can feel strange to call this income when you are facing a much larger repair bill. However, the payment represents part of the tenant’s deposit that the landlord is now entitled to keep.
Under the cash basis, a refundable security deposit is normally excluded from property income until the landlord becomes legally entitled to retain some or all of it at the end of the tenancy. The retained amount then becomes a property business receipt. HMRC explains this in its guidance on security deposits.
For this landlord, the £150 should therefore be recorded as property income, with a clear description such as “Tenant deposit retained for damage” and a reference to the property. Keep the deposit scheme’s settlement statement.
Hammock provides guidance on recording deposits and amounts retained for damage. Check the appropriate category in your account rather than treating the payment as a refund of your own money.
Can the landlord claim the £3,000 repair bill?
The £3,000 is currently an estimate. Under the cash basis, allowable expenses are generally recognised when paid, so the expected bill is not yet a deductible expense.
The deposit recovery and subsequent spending should be recorded separately.
If £3,000 is later paid for fully allowable repairs in the same tax year as the £150 receipt, the effect is:
In this illustration, a £150 tenant deposit amount retained for damage is treated as a property receipt when the landlord becomes entitled to keep it. The separate £3,000 repair bill must be checked to confirm it is an allowable repair rather than capital improvement. If it is a wholly allowable expense, the illustrative net reduction in property profit from these transactions is £2,850.
This is an illustration, not confirmation that every item of the planned work qualifies. It also assumes actual expenses are claimed rather than the property allowance.
Do not record £150 as income and also deduct it from the £3,000 expense. That would count the recovery twice. Equally, a reduction in taxable profit is not a refund of the repair bill. The final tax position depends on the property business as a whole.
Repairs improvements and replacement items are different
When someone says they are “renovating”, that can mean several things.
Repainting damaged walls to restore their condition may be a repair. Adding an extension is an improvement. Replacing a tenant’s damaged carpet or fridge may fall under replacement of domestic items relief.
These distinctions affect what can be claimed against rental income.
A builder’s invoice may contain both repairs and capital improvements. Ask for an itemised breakdown so the costs can be assessed separately. A reasonable modern equivalent can still qualify as a repair; a newer material does not automatically make the work capital. HMRC’s repairs guidance explains the distinction.
For replacement domestic items, the rules generally cover replacing an existing item provided for tenants, rather than its initial purchase. Where the replacement is an upgrade, relief may be limited to an equivalent replacement cost. Delivery, disposal costs and proceeds from selling the old item can also affect the calculation. See HMRC’s replacement of domestic items guidance.
Before entering everything under “Repairs”, understand what was purchased and why.
Why your MTD software may need setting up
A separate sole trader example raised another problem.
The client opened a new Xero account for MTD and connected his business bank account. He then struggled to find a suitable category for transfers to his personal account and cash withdrawn for personal use.
The account list included a “Director’s current account”. A friend suggested using it because he had received similar advice from his accountant.
When we investigated, we found company categories in that client’s chart of accounts that did not suit his sole trader business. A suitable drawings account was missing.
The chart of accounts is simply the list of accounts or nominal codes, used to organise transactions. It can be adapted to suit your business.
This was a setup issue in that particular account. It does not mean every Xero account has the same problem.
How sole traders should record personal drawings
Money a sole trader takes from the business for personal use is normally recorded as owner’s drawings.
It is not wages paid to an employee and it is not an allowable business expense. Taking money out does not reduce the taxable profit of the business (we’ve seen it recorded incorrectly under other ‘categories’ too). HMRC specifically excludes personal withdrawals from allowable expenses.
A director’s current account describes a different relationship involving a company and its director. It is a confusing label for a sole trader’s personal withdrawals.
The practical solution is to create a suitable drawings account or adapt the wider chart of accounts where necessary.
The name alone is not enough. The account type and tax settings must also be appropriate. An expense account labelled “Drawings” would still give the wrong result.
For landlords who own property personally, moving money from a rental account to a personal account similarly does not create an allowable property expense. Ownership through a limited company requires different treatment.
How to add a sole trader drawings account in Xero
For straightforward personal cash withdrawals or transfers by a sole trader, a suitable account can be set up as follows:
Open Chart of accounts in Xero’s accounting settings.
Select Add Account.
Choose Equity as the account type.
Enter an unused account code.
Name the account Owner’s Drawings.
Add a description such as “Money withdrawn by the owner for personal use”.
Select No VAT for these straightforward personal withdrawals.
Save the account.
Then use that account to categorise the relevant personal withdrawals during bank reconciliation.
Xero’s menus can change, so refer to its current instructions for adding or editing accounts.
If transactions have already been recorded incorrectly, review those entries too. Creating a new account does not correct earlier postings automatically.
Where several categories need changing, a suitable chart of accounts can be imported. However, Xero explains that imports can update existing accounts. Check the impact before importing into an account already in use.
Are ATM withdrawals always drawings
No. The purpose of the cash matters.
Cash withdrawn for personal spending is drawings. Cash withdrawn to pay business or property costs should be tracked as cash held for those purposes, with the subsequent purchases recorded separately.
For example, you might withdraw £200, spend £140 on decorating materials for a rental property and keep £60 for personal use. Your records need to show the supported property purchase and the personal withdrawal separately, without counting the original £200 withdrawal as another expense.
Keep receipts and a record of the cash movements. “ATM withdrawal” on a bank statement does not explain what the money bought.
Other landlord transactions that need attention
Rent received through a letting agent: if the tenant pays £1,200 and the agent retains £120 in fees, the £1,080 bank receipt does not show the whole transaction. Record the gross rent and agent fee separately.
Mortgage payments: a repayment mortgage includes capital and interest. Capital repayments are not deductible. For an individual residential landlord, qualifying finance costs generally receive a basic rate tax reduction rather than being deducted from rental profit.
Expenses paid personally: a genuine property cost paid from your personal account can be missed if you rely only on the rental bank feed. Record the supported expense and how you funded it.
HMRC’s rental income guidance explains allowable property costs and residential finance restrictions.
Frequently asked questions
Is rental income the same as sole trader income
Ordinary rental income is normally reported as property income. If you also run a sole trader business, MTD requires separate records and updates for those income sources. See HMRC’s digital record guidance.
Does MTD compatible software guarantee correct bookkeeping
No. Compatibility enables the relevant digital record keeping and reporting functions. You still need suitable accounts, accurate records and correct tax treatment.
Can I use a director account for sole trader drawings
A properly configured owner’s drawings account provides a clearer and more appropriate record. Check the account type and tax settings as well as its name.
Can I claim expenses and the property allowance together
No. If you claim the £1,000 property allowance, you cannot also deduct actual property expenses. Compare the available options before deciding.
Get help with your MTD records and chart of accounts
Doing your own bookkeeping can work well. Asking a question when something does not fit is part of doing it properly.
If your categories are confusing or do not give you a suitable choice, contact Business Help UK Group. Tell us which software you use and whether you are a sole trader or a landlord with personally owned property. We can email you a suitable chart of accounts and explain how to use it.
From our offices in Romford and Chatham, we help clients understand their records, review their software setup and manage their Self Assessment obligations.
Find out about BHUK Group’s Self Assessment and personal tax services.
