Homeowners can legally increase their tax-free Personal Allowance to £16,320 by taking part in HMRC's Rent a Room scheme and submitting a self-assessment tax return for the current tax year.
The standard income tax Personal Allowance remains at £12,570, the maximum amount most people can earn before paying tax. Income between £12,570 and £50,270 is taxed at 20%, rising to 40% above that and 45% for every pound over £125,140 for additional rate taxpayers.
Tax thresholds are currently scheduled to be frozen for five more years unless changes are announced in the upcoming Budget, which means more people could be pushed into paying tax or higher tax bands as inflation raises wages, a phenomenon known as 'fiscal drag'.
How the Rent a Room scheme works
Under the scheme, you can earn up to £7,500 from letting out a furnished room in the home you live in before the income becomes taxable. The allowance cannot be applied to buy-to-let properties.
You must declare the income to HMRC through a self-assessment tax return. If you earn £7,500 or less from renting out a room, which works out at £625 per month, you are exempt from paying tax on that income.
Boosting the allowance with a partner
If you share the rental income with a partner, the allowance is split, so each person can claim an extra £3,750 tax-free. This takes each person's tax-free allowance to £16,320.
Alternatively, you can opt out of the scheme and have the income taxed normally, which may be beneficial if you made a loss from letting the room and want to offset it against your tax burden on another buy-to-let property.
According to the government: "The Rent a Room Scheme lets you earn up to a threshold of £7,500 per year tax-free from letting out furnished accommodation in your home. The threshold is halved to £3,750 if you share the income with someone else."
"You can let out as much of your home as you want. The tax exemption is automatic if you earn less than your threshold. Which means you do not need to do anything. You must complete a tax return if you earn more than your threshold. You can then opt into the scheme and claim your tax-free allowance. You do this on your tax return. You can choose not to opt into the scheme and instead record your income and expenses on the property pages of your tax return."
