Property taxation is a complex subject that requires expert professional advice. PropertyInvesting.net are not experts on taxation – this section is meant more to get you warmed up to some opportunities for optimisation, some pit-falls and highlight the positive aspects of property taxation that has been designed by the UK Government to help stimulate property investment and prudent economic activity.
First and foremost, any property activity has to adopt the fiscal and regulatory law of the land – it is imperative and obligatory that an investor does this. Financial and fiscal integrity is crucial – you will be asked by solicitors, tax planners, accountants, banks and building societies to provide thorough, accurate and objective financial disclosure of your assets, liabilities and accounts.
It’s simply not worth moving into the grey zone and worse still outside the law. It will only catch up with you one day – can cause a never ending series of cover-ups and lead to a damaged reputation at best and fines and imprisonment at worst – yes, remember not following tax and accounting laws is a crime. I advise checking your understanding of any tax steer given below by a professional taxman. As they say, there are only two certainties in life – they are death and taxation.
Below is an introduction to the major taxation areas associated with property for UK residents:
See also separate sections on Expatriate Taxation and Property Investment Funds (PIFs).
Capital Gains Tax
If you are tax domiciled in the UK and are resident for tax purposes in the UK you will be liable for Capital Gains Tax on any capital gain you make on property, unless it is your primary residence. There is tapered relief from the standard rate of 40% for properties you have owned for many years, albeit the tapering of the tax takes many years to kick-in.
Some people have rolled their properties into a company to reduce capital gains tax liabilities – however, you will then have to pay Corporation Tax on net income and you will likely be held liable for Capital Gains Tax if you were to sell the company or part of it. You will however be able to offset rental income against expenses such as mortgage costs and company operating costs.
The standard main rate of Corporation Tax is 30% (depending on profit levels and company structure). Even if you gear up your property portfolio as prices rise, the tax liability does NOT go away. For instance, if you bought a property at 75,000 pounds and had borrowing of 60,000 pounds (80%), then the value goes up to 160,000 pounds and you gear up to 80% by borrowing to 128,000 pounds by getting an advance of 68,00 pounds – if you sell within say four years at 160,000 pounds, your tax bill will be 34,000 pounds whilst your equity will only be 32,000 pounds. On selling such a property you would have to pay the Inland Revenue 2,000 pounds!
So there are examples of when a property investor cannot afford to sell if prices have risen strongly, they have high gearing and they have re-invested further advances in property. This is a potentially dangerous situation to be in – this is one reason why most Banks and Building Societies normally only lend to between 70-80% of the value of property for investment purposes and look at your total portfolio of assets and liabilities. Your Capital Gains Tax liabilities should be considered whenever you gear up and purchase another property – you need to be able to sell a property to release equity in case you have a large unexpected expense.
You will be liable to income tax at the standard rates for individuals on buy-to-let and commercial property depending on your salary, business and rental incomes.
Many investors choose to gear themselves up with high mortgage costs that just about break even against rental income minus running costs and hence their costs offset their profits – leading to a zero income tax annual liability on their property portfolio. Deficits from previous years can be rolled-over to the current year, so if you have “done badly” in cashflow terms in previous years and have a rolling deficit, even if you make a small net income in a year, you may still not have to pay income tax on these buy-to-let income proceeds.
As a guidance though, making a healthy positive cashflow in the form of net passive income is of course very desirable – needing to pay income tax on property proceeds should be seen as a success.
Any property assets held by an individual will be liable to 40% Inheritance Tax on anything over a threshold of 263,000 pounds. Therefore, if you have property worth 500,000 pounds, on your departing your offspring will be liable to pay a bill of about 95,000 pounds.
This would lead most families to having to sell the property within a certain time window, pay bills and then split the proceeds consistent with a Will if there was one. An exception is if the owner was to be survived by a spouse and the property is in their joint names. If this was the case, there is no Inheritance Tax bill until the spouse departs.
Some families have chosen to set up Trusts for high value properties whereby the value of the property is gifted to their offspring, and the parents make rental payments to the offspring – up until recently, if the parents were to survive for 7 years after the Trust was set up, this reduced their Inheritance Tax Liability to zero.
This loop-hole has recently been closed in that the Chancellor has announced that such Trusts on a retrospective basis going back decades have until April 2005 to unscramble them or they will have to pay income tax on a proper market rate rental for such property. The appropriate market rental rate would likely have to be proved to be appropriate and objective probably going back many years for such Trusts.
This is an example of retrospective taxation – something some commentators see as a new precedent – because of this change, there could be other such changes for property taxes and trusts in the future - this does create an increased sense of fiscal uncertainty amongst some investors. This has to be borne in mind when investing – that negative tax changes can affect your portfolio – and indeed the market price for property in the future. On the positive side, the recent announcement of Personal Investment Funds (PIFs, see below) is likely a positive development for property taxation which could offset the negative impact of the above change for some people.
Note that if you were to pass on and leave a portfolio of highly geared properties with a high Inheritance Tax burden, there could be cases where some properties might have larger Inheritance Tax liability than equity, in a similar way to the Capital Gains Tax example shown above. The last thing you need is to leave your offspring with either not being able to afford to sell the properties because of the tax burden, or having to sell the lot in a “fire-sale” because of the tax liabilities. Proper tax planning and financial gearing using a reputable professional is very important.
Non-standard Tax Planning and the Inland Revenue
Another announcement by the Chancellor in March 2004 was that there will be greater scrutiny on Tax Planning and constructions from professional companies specialising in tax planning that go outside the normal fiscal planning processes. These tax vehicles will have to be lodged in some form of ledger with the Inland Revenue, presumably to allow them to okay them or challenge them.
The new directive is still rather vague, but one thing is for sure – the Inland Revenue will want to know more about how Tax Planners are reducing tax liabilities for their clients with a view to closing some loopholes they believe may be being abused.
Most Trusts and Company structures are standard and would not have to be lodged – further consultation and clarification on this will take place in the coming year. It is important to understand that any fiscal optimisation suggested by Tax Planning professionals has a chance of challenge and rebuttal if it is a non standard procedure.
As an investor, you need to consider this carefully since the downside is that if you are advised that some fiscal optimisation is possible, you go ahead with it at high cost and time, then find it is challenged and you get a huge tax bill or have to unravel it at high expense – if you cash-flow is not healthy – this could fold your company or you as an individual.