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Well you didn't want a picture of an accountant did you?

PROPERTY TAX IS A MINEFIELD...

BANG!

There are separate tax regimes depending on whether you are a property developer, or a property investor. Property transactions can give rise to several different taxes: income tax, capital gains tax, inheritance tax, national insurance and VAT. But don't panic - here's a lay-person's guide, supplied by experts Henton & Co.

NASTY CAPITAL GAINS TAX

  • A property investor predominantly holds properties as long-term investments.
  • Income tax is payable on rental profits (income less expenses). Allowable expenses for tax purposes include:
    • Interest and other finance costs
    • Repairs
    • Heating and lighting costs borne by the landlord
    • Insurance costs
    • Letting agent's fees
  • The accounting period for an individual property investor is always a ‘fiscal' year; i.e. 6th April to 5th April. You cannot ‘choose' to have your accounting year end on another date in the calendar.
  • The main tax advantage of a property investment business is that profits arising on property disposals are taxed under the capital gains tax regime, rather than the income tax regime. There are many different capital gains tax reliefs available and the maximum long-term tax rate is only 24% (for properties held for 10 years or more).
  • However, one of the tax disadvantages of a property letting business is that property held on death is fully liable to inheritance tax (subject to exceeding the ‘NIL rate band' - £285,000 06-07).

WAKE UP DEAR!

  

KEEP GOING - THIS REALLY IS USEFUL

Property Dealing and Development

Property development businesses predominantly acquire properties to carry out building or renovation work with a view to selling the developed properties at a profit.

A property trader generally only holds onto properties for short-term gain. Properties are bought and sold frequently and are held as trading stock. Such traders are sometimes referred to as property dealers.

Where your property business is deemed to be a trade, such as property development or property dealing, you will be taxed under a different set of principles to the property investor:

  • Properties held for development or sale, are treated as trading stock rather than capital assets.
  • Taxpayers with property trades may choose any calendar date as their accounting year end.
  • Profits on property disposals are subject to both income tax and Class 4 national insurance contributions (NICs). Property traders must also pay Class 2 NICs.
  • Capital allowances will be available only on your own business' long-term assets.
  • Trading losses may be set off against all of your other income and capital gains for the same tax year and the previous one.
  • The same trade may involve both UK and overseas properties. 

 

  • Therefore, the disadvantage of being classified as a property developer is the fact that all profits are dealt with under the income tax regime and not under the capital gains tax regime, which is generally more favourable. This means that reliefs such as the annual capital gains tax exemption, principal private residence exemption and private letting relief will not be available.
  • However, the business itself, if it has any value (e.g. goodwill) will attract business asset taper relief (capital gains tax relief) when it is sold and business property relief is available for inheritance tax purposes. (Basically, no inheritance tax to pay on death).

 

STICK WITH IT! YOU'RE DOING WELL!

VAT and Property

  • Value Added Tax (VAT) is complicated at the best of times. Property VAT is even worse!
  • Part of the problem is that property transactions can give rise to differing rates of VAT: 0% , 5%, 17.5%, exempt from VAT and ‘outside the scope' of VAT.

Residential Property Letting

  • The letting of residential property is an exempt supply for VAT purposes. VAT is therefore not chargeable on rent, and VAT cannot be recovered on expenses.
  • The provision of ancillary services (e.g. cleaning or gardening) may be standard rated and hence subject to VAT at 17.5%, if the value of annual supplies of these services exceeds the VAT registration threshold (£61,000 from 1st April 2006).

 

NOW'T IN IT! IT'S ZERO RATED

 

  • Sales of newly constructed residential property are zero-rated for VAT purposes. This means that the developer can recover all of the VAT on their construction costs without having to charge VAT on the sale of the property. (In theory, VAT is charged, but at a rate of 0%).
  • This treatment is extended to the sale of a property which has just been converted from a non-residential property into a residential property (e.g. converting a barn into a house).
  • Other sales of residential property are generally an exempt supply (VAT is not charged).

 

PAY LESS VAT (ALMOST THERE!) 

Conversions

A reduced VAT rate of 5% is available in respect of any building work carried out on a residential property where the work results in a change in the number of dwellings in the property, for example:

  • One house into several flats
  • Two or more flats into a single house
  • Two semis into a single detached house

 

  • The 5% reduced rate also applies to conversions of commercial property into residential use.
  • Approved alterations to listed properties are eligible for zero-rating. 

 TAX ON YOUR PLACE IN THE SUN!

 

  • A common misconception by investors in overseas property is that as long as overseas rental profits are kept in an ‘off-shore' bank account, they won't be liable to UK tax........Unfortunately this is not correct!
  • UK residents are liable to UK income tax on income arising from assets any where in the world, regardless of whether or not this income is brought into the UK.
  • There is also likely to be tax to pay on rental profits in the country in which the property is located. In other words your overseas rental profits are subject to tax in two countries!
  • In practice however, there is a series of double tax treaties in place between the UK and many countries throughout the world; to ensure that tax is not paid twice on the same source of income. For a UK resident investing in overseas property, tax would be paid in the overseas location, and such tax would then be set off against your UK liability on the same profits.
  • The overseas tax to be set off cannot exceed the UK tax liability; in other words if the overseas tax rate is less than the UK, you pay ‘the difference' in the UK, up to what the UK tax rate is. However, if the overseas tax rate is more than the UK rate then this has to be ‘suffered'; i.e. the UK taxman won't give you a refund just because you paid more tax abroad than you would have done had the property been in the UK.
  • Many EU countries do however have income tax rates lower than the UK.
  • The capital gains tax regime in most countries is broadly similar to the UK; i.e. the gain is basically calculated as the difference between sales proceeds and cost.
  • Again, as with income tax, there are clauses in the respective double tax treaties to ensure that capital gains tax is, in effect, not paid twice. With some countries, the tax treaties can be even more generous! For example, if you retire to Spain, but maintain a rental property in the UK; the UK / Spain double tax treaty states that should you sell the UK property, then Spain will not tax it as the property is ‘located' in the UK; but equally, the UK will not tax it because you are no longer UK resident (a condition for paying UK capital gains tax). Hence the property is sold tax free! It is therefore worthwhile considering the tax treaties between the UK and the country you are going to invest / live in, as there may be some pleasant surprises! 

 

If you've now lost the will to live, you may like to discuss your own property tax issues with Simon Gray at Henton & Co. Tel: 0113 246 7900, simon@hentons.com