Journal :: Taxation for Property Investors

Published: December 19, 2005
Author: Graham Dragon
Category: Tax
Permalink: Taxation for Property Investors

This article was written by Graham Dragon of Adviser Breakthrough Solution, and was originally published on the 8th of December 2005 by Financial Adviser. ? Copyright Financial Times Business Limited - 2005.

Taxation for Property Investors

You are probably familiar with the principal tax planning techniques for ?Mr and Mrs Average Client? and include tax saving measures along with all the other financial planning techniques you use when advising your clients. But in my experience a lot of us shy away from giving tax advice to our property investor clients. It seems so complicated, and sometimes it seems as if property investors know more about their tax problems than we do. Also in my experience, a lot of us have many property investors in our client banks, particularly if you count people with ?ordinary? jobs who simply happen to own buy to let properties.

Tax planning for property investors is a little different, and perhaps a little more complicated. You could write a whole book on the subject ? in fact, I have. But if you can grasp the basic principles this should enable you to add greater value to the advice you give and, perhaps, take on additional and wealthier clients.

Before you can begin to tax plan, you have to understand the basics of the tax itself ? which is where I will begin. In a future article I can then explore some of the ways you can help your client reduce the tax burden, although even from this article you should see clear steps some of your clients could take to do so.

Is Your Client Really a Property Investor?

You must first establish what kind of property investor your client is. Or rather, whether your client is a property investor at all or something quite different? The tax treatment depends very much on your answer to this question. There are three main kinds of property business from which a client can profit, and which you might think of as property investment, but only one of which is truly property investment and taxed accordingly:

• Property Investment
• Property Development
• Property Trading

Tax Treatment	Property Investor	Property Developer	Property Trader
National Insurance on profit	No	Yes	Yes
Income pensionable ?	No *	Yes	Yes
Basic tax rate	20%	22%	22%
Tax on profit on sale	CGT, with Taper Relief	Income Tax	Income Tax
Can losses be offset against other income ?	No *	Yes	Yes
Expenditure on unsuccessful purchases allowable ?	No	Yes	Yes
Taper relief on investment in business	No	Yes	Yes
Inheritance Tax on business value	Yes *	No	Yes

* Unless the business is Furnished Holiday Accommodation

A true property investor, in the eyes of Revenue & Customs, buys property with the intention of receiving rental income.

Ultimately this investor probably hopes for a capital gain when the property is eventually sold, but this gain was not the main benefit in mind when the property was purchased.

A property developer buys property, develops it in one way or another (perhaps not even touching the property itself, but simply obtaining improved planning permission), and then sells it on ? hopefully at a profit. If the developer holds onto the property for some time there may also be some rental income, but this income was not the main benefit in mind when the property was purchased.

A property trader simply buys property at what he or she regards as a low price, hoping to sell it on at a profit without needing to spend much or even anything at all improving it. There may be a need to clean it up a bit before putting it on the market, or perhaps even do some redecorating, but there will probably be no major work done on it. It is possible the trader will receive some rental income ? the property may have been purchased with a sitting tenant, for example ? but income was not the main benefit in mind when the property was purchased.

In the table you will see a comparison of the tax treatment of each of the three types of activity. Generally speaking, a client would probably prefer to be treated as a property investor, although a developer does have a few advantages. Rarely would anyone wish to be treated as a property trader.

Intention

In most cases, it is pretty obvious which of the three business types your client is operating, but be very careful with the borderline grey areas. Notice that it is your client?s intention that is important. Courts will invariably look at the facts to determine intention, but if your client can satisfy the Revenue or the court that he or she had a genuine intention to operate, say, a rental property business even though it looks on the surface as though he or she has a property trading business, then the more favourable ?property investor? tax treatment will apply.

For example, a client buys a property with the intention of renting it out, but then is given an offer to sell it for a much higher price. The client decides to accept the offer and use the money to find another, more expensive rental property.

In the absence of evidence to the contrary, the Revenue might well decide your client is a property trader, and charge Income Tax on the sale profits. This means the basic rate will be 22% rather than the 20% applied to investment income, and the client will be unable to use the annual exemption for Capital Gains Tax ? currently reducing the taxable profit by ?8,500.

However, your client received good advice from you, establishing from the outset that her intention was to invest in buy to let property. You advised her to write to her accountant telling him of this new business interest and asking him to provide some accountancy services for it, which she duly did. The accountant can produce this letter in court, if necessary, as clear evidence of your client?s intention. Other evidence would, of course, probably be needed in a case like this. For example, the letter from the person who made the high offer, showing this offer came out of the blue rather than being solicited. And perhaps the icing on the cake being the facts of your client?s ongoing property rental business, with the sale proceeds ploughed back into another property which she has retained rather than selling for a profit.

Furnished Holiday Let

One important sub-division of property investment is investment in furnished holiday let. As you will see from the table, this has some significant advantages compared to normal property investment ? inclusion of income for pension planning, ability to offset losses against other income (including salary), and 100% business property relief for Inheritance Tax being the main advantages.

For property to count as Furnished Holiday Let it must fit the following criteria:

• It must be situated in the UK
• It must be let on a commercial basis with a view to making a profit
• It is furnished, and the tenant has the full use of that furniture
• It meets the criteria of ?Qualifying Holiday Accommodation?

The criteria of ?Qualifying Holiday Accommodation? are:

• It must be available to the public for at least 140 days a year
• It must actually be ?holiday let? for at least 70 days a year
• ?Holiday let? is defined as no longer than 31 continuous days
• There must not be more than 155 days of longer term occupation

Each property you wish to include as Furnished Holiday Let must meet all the above criteria, with one notable exception. If you have more than one Furnished Holiday Let property you can pool the days actually holiday let over all those properties.

Provided there is an average of 70 days per property and all the other criteria are met, all the properties will qualify even if, for example, one property was only holiday let for, say, 55 days.

A Furnished Holiday Let business is regarded as a completely separate business from the remaining property investment activities. Your client may have a number of properties, some commercial, some residential, and some Furnished Holiday Let, and may believe he is running three businesses, but in the eyes of the Revenue it is two ? the commercial and residential letting is one business, and the Furnished Holiday Let is another.

VAT

If your client is simply a buy to let investor in the residential market, there are no VAT implications. The property is exempt from VAT and so is the rent ? which also means the client cannot claim back VAT on any expenditure. There is no need to register for VAT (in fact, it is impossible to do so) and incur any of the administrative headaches no matter how large the business gets.

Commercial property less than 3 years old is subject to standard rate VAT.

Commercial property more than 3 years old is normally exempt from VAT, but your client can opt to tax it when purchasing the property. An option to tax is made property by property ? your client may elect to tax one property and not another. The effect of opting to tax is that VAT is charged on the rent, but is also claimed back on expenses. Where the tenant is also VAT registered, the VAT on the rent is only a cashflow issue, not a profit issue, so may not be a major problem, but for a tenant who is not VAT registered, the VAT on the rent is the same as simply paying higher rent.

Stamp Duty Land Tax

The final tax I wish to consider briefly is Stamp Duty Land Tax.

Stamp Duty Land Tax is payable on any purchase of land or property for a consideration at or over a value set in the Finance Act. In 2005/06 that threshold is ?120,000 for most residential properties and ?150,000 for non-residential properties and for residential properties in ?disadvantaged? areas. The rates are as follows:

Threshold to ?250,000	1%
?250,000 to ?500,000	3%
Over ?500,000	4%

You cannot reduce or avoid Stamp Duty Land Tax by, for example, buying half the property from one person and the other half from that person?s spouse. The two transactions are referred to by Revenue and Customs as ?linked transactions? and the Stamp Duty Land Tax position is exactly the same as if you had simply entered into only one transaction.

You can probably understand the need for anti-avoidance provisions such as described above, but the effect of the ?linked transactions? anti-avoidance can be quite draconian for a property investor. If the investor buys more than one property from the same person ? for example a number of repossessed properties from the same financial institution ? all these transactions can be regarded as linked transactions. The investor could end up paying 4% Stamp Duty Land Tax on a series of five different property purchases where each property only cost ?100,000.

So much for the various taxes your property investor client pays. What can you do to reduce this tax burden? Well, keep reading Financial Adviser and I hope to give you a few pointers in a future article.

Graham Dragon ATT
Adviser Breakthrough Solution

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About Graham Dragon

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