How do I handle service charges and ground rent in my accounts?

At Towerstone Accountants we provide specialist property accountant services for landlords property investors and individuals dealing with property tax and reporting obligations across the UK. This article has been written to explain How do I handle service charges and ground rent in my accounts in clear practical terms so you understand how the rules apply in real situations. Our aim is to help you make informed decisions avoid costly mistakes and know when professional advice is worthwhile.

Service charges and ground rent cause more confusion than almost any other area of property accounting. I regularly see landlords, leaseholders, and small property companies recording them incorrectly, claiming deductions they are not entitled to, or missing deductions they should have taken. The problem is that service charges and ground rent sit awkwardly between property law, accounting, and tax, and the correct treatment depends on who you are and what role you play.

In this article, I am going to explain clearly how service charges and ground rent should be handled in your accounts, when they are deductible, when they are not, how VAT fits into the picture, and how HMRC expects them to be reported. I will cover the position for individual landlords, leaseholders, and property companies, because the treatment is not identical in every case.

Everything here reflects current UK practice as applied by HMRC and set out on GOV.UK, but explained in practical accounting terms rather than legal language.

What Service Charges and Ground Rent Actually Are

Before we talk about accounting treatment, it is important to be clear on what these terms mean.

Service Charges

Service charges are amounts paid by a leaseholder to cover the cost of maintaining and managing a building or estate.

They often cover things like:

Cleaning of communal areas

Repairs and maintenance to shared parts

Gardening and grounds maintenance

Insurance of the building

Managing agent fees

Lighting and utilities for communal areas

Service charges are usually paid monthly, quarterly, or annually and are often based on estimates, with later adjustments once actual costs are known.

Ground Rent

Ground rent is a separate charge paid by a leaseholder to the freeholder for the right to occupy the land.

It does not relate to services or maintenance. It is simply a contractual payment under the lease.

Ground rent is usually:

A fixed annual amount

Payable regardless of services provided

Not linked to actual costs

These differences are critical when it comes to accounting and tax treatment.

Why Correct Treatment Matters

Service charges and ground rent often involve large sums over time and are closely scrutinised by HMRC.

Incorrect treatment can lead to:

Overstated or understated profits

Disallowed expense claims

VAT errors

Problems during HMRC enquiries

Incorrect reporting in Self Assessment or company accounts

Getting this right from the outset saves time and stress later.

The Starting Point: Who Are You in the Transaction?

The accounting treatment depends heavily on your role.

You may be:

A landlord who pays service charges and ground rent

A leaseholder subletting a property

A freeholder or managing agent collecting service charges

A property company holding leasehold assets

Each role has a different accounting perspective.

In this article, I will focus primarily on landlords and property owners paying service charges and ground rent, as that is where most confusion arises.

Service Charges in a Landlord’s Accounts

If you are a landlord who owns a leasehold property and rents it out, service charges are usually a revenue expense.

This means they are generally deductible when calculating your rental profit, provided they meet the usual rules.

When Service Charges Are Deductible

Service charges are normally allowable as a rental expense if they relate to:

The day-to-day maintenance of the property

The management of communal areas

Services that keep the property lettable

Common deductible service charge elements include:

Cleaning

Gardening

Repairs to shared areas

Managing agent fees

Building insurance

These costs are treated in the same way as if you paid them directly yourself.

When Service Charges Are Not Fully Deductible

Not all service charge elements are automatically deductible.

Service charges that include capital expenditure must be treated differently.

Examples include:

Major structural works

Replacement of roofs

Installation of new lifts

Significant improvements rather than repairs

The revenue portion may be deductible, but capital elements are not deducted from rental income. Instead, they may be considered for capital gains tax when the property is sold.

This is one of the most common mistakes I see in practice.

Ground Rent in a Landlord’s Accounts

Ground rent is simpler in principle.

If you are a landlord paying ground rent on a leasehold property that is let out, the ground rent is usually an allowable expense.

It is treated as:

A revenue expense

Deductible against rental income

Claimed in the year it is paid or incurred

Because ground rent is a contractual cost of holding the property, HMRC generally accepts it as an allowable deduction.

Service Charges and Ground Rent for Owner Occupiers

If you live in the property yourself and do not rent it out, service charges and ground rent are not deductible for income tax purposes.

They are private expenses.

However, they may still be relevant for capital gains tax calculations when the property is sold.

Accounting for Service Charges Paid in Advance

Service charges are often billed in advance based on estimates.

From an accounting perspective, you should:

Match the cost to the period it relates to

Apportion charges if they cover more than one accounting period

For example, if you receive a service charge demand covering six months, part of the cost may relate to the next accounting year.

In practice, many small landlords use a cash basis, in which case the timing is simpler and the expense is usually claimed when paid.

Year End Adjustments and Balancing Charges

Service charge accounts often include:

Balancing charges

Refunds

Additional demands once actual costs are known

These adjustments should be recorded in the year they are agreed or paid, depending on your accounting basis.

It is important not to ignore these adjustments, as HMRC expects the figures to reflect reality rather than estimates.

VAT and Service Charges

VAT treatment is one of the most misunderstood areas.

VAT on Service Charges

Whether VAT applies to service charges depends on:

The VAT status of the freeholder or managing agent

The nature of the services provided

Whether the property is residential or commercial

For residential property:

Many service charges are VAT exempt

Some elements may still attract VAT

For commercial property:

Service charges are often subject to VAT

Especially where the freeholder has opted to tax

If VAT is charged correctly on the service charge invoice and you are VAT registered, you may be able to reclaim the VAT if the property is used for taxable supplies.

If the rental income is VAT exempt, VAT on service charges is usually not recoverable.

VAT and Ground Rent

Ground rent is generally VAT exempt.

This means:

No VAT is charged on ground rent

There is no VAT to reclaim

The full amount is treated as the expense

This is another reason ground rent is often simpler to deal with than service charges.

Service Charges and the Cash Basis vs Accruals Basis

How you account for service charges can depend on whether you use the cash basis or accruals basis for your property income.

Cash Basis

Under the cash basis:

Expenses are claimed when paid

Income is taxed when received

Most individual landlords with rental income under the threshold use the cash basis by default.

This makes service charge accounting relatively straightforward.

Accruals Basis

Under the accruals basis:

Expenses are matched to the period they relate to

Prepayments and accruals may be required

This is more common for companies and larger landlords.

Using the accruals basis requires more care, particularly with advance service charge demands.

Service Charges Where You Recover Them From Tenants

If you charge tenants service charges separately, the accounting treatment changes.

In this case:

Service charges paid to the freeholder are expenses

Service charges recovered from tenants are income

The net effect may be nil, but both sides should still be recorded.

HMRC expects:

Service charge income to be declared

Service charge expenses to be claimed

Netting them off without recording both sides can cause problems during enquiries.

Ground Rent Recharged to Tenants

Ground rent is rarely recharged to tenants in residential settings.

If it is recharged:

The recharge is income

The ground rent paid remains an expense

Again, both sides should be recorded.

Service Charges for Mixed Use Properties

Mixed use properties introduce additional complexity.

If a property includes both residential and commercial elements:

Service charges may need to be apportioned

VAT recovery may be restricted

Expenses may need to be split between taxable and exempt income

Apportionment should be fair, reasonable, and consistent year to year.

Service Charges Held on Trust

If you are a freeholder or managing agent collecting service charges on behalf of leaseholders, the treatment is different.

In many cases:

Service charge funds are held on trust

They are not your income

They do not belong in your profit and loss account

Instead, they are shown as a liability or trust balance.

This is a specialist area and often misunderstood, especially by small property companies.

Record Keeping for Service Charges and Ground Rent

Good records are essential.

You should retain:

Service charge demands

Annual service charge accounts

Breakdown of costs

Ground rent demands

Proof of payment

VAT invoices where applicable

These records should be kept for at least six years.

Service charge disputes are common and good records protect you.

Common Mistakes I See in Practice

Some of the most frequent errors include:

Claiming capital service charge items as revenue expenses

Ignoring balancing charges

Netting off recharged service charges incorrectly

Reclaiming VAT where rental income is exempt

Treating ground rent as capital

Poor or missing documentation

Most of these mistakes are unintentional but still costly.

How HMRC Looks at Service Charges and Ground Rent

HMRC tends to focus on:

Whether expenses are revenue or capital

Whether VAT recovery is justified

Whether income and expenses are both recorded

Whether figures align with lease terms

Clear, consistent treatment makes HMRC enquiries far easier to deal with.

Practical Example

Imagine you own a leasehold flat that you rent out.

You pay:

£2,400 annual service charges

£300 annual ground rent

The service charges include £400 for major works.

In your accounts:

£2,000 of service charges is deductible

£400 is capital and not deducted from rental income

£300 ground rent is deductible

This kind of split is very common and often missed.

When I Recommend Professional Advice

I strongly recommend advice if:

Service charges are significant

Major works are involved

VAT is being charged on service charges

The property is mixed use

You are a freeholder or managing agent

Service charge accounting is simple when done right and painful when done wrong.

Practical Summary

In practical terms:

Service charges are usually deductible revenue expenses

Capital elements must be separated

Ground rent is usually deductible

VAT recovery depends on the VAT status of rental income

Recharged service charges must be recorded as income

Good records are essential

Final Thoughts

Service charges and ground rent are not just administrative annoyances. They have a real impact on your taxable rental profit and your compliance position.

My advice is always to look beyond the headline figure. Understand what the service charge actually covers, separate revenue from capital, and make sure the VAT treatment aligns with your rental income. A small amount of care each year can prevent years of confusion and unnecessary tax later.

You may also find our guidance on How do I calculate my rental income profit and How do I set up accounting for multiple rental properties useful when exploring related property tax questions. For a broader overview of property tax reporting and planning topics you can visit our property hub which brings all related guidance together.