Top 10 tax considerations for property businesses
Introduction to Property Tax
Our clients here at The Peloton work incredibly hard to make their businesses a success. Few, however, want to continue working for the indefinite future. As a result, we frequently have conversations with clients about their retirement plans.
One plan our clients frequently have is to buy property with the aim either to rent it out or sell it at a profit. While this works for many, there are lots of tax considerations worth thinking about. We have included a few of these below.
Top 10 Property Tax Considerations
1. Trader vs. Investor – You buy a property. Are you planning to quickly convert the attic into a second bedroom, do up the bathroom, give it a fresh lick of paint and flip it for a massive profit? If so HMRC will likely view you as a trader – someone who buys with a main aim of selling at a profit. Alternatively, if your plan is to rent it out for the foreseeable future, you are likely to be an investor.
If an individual trader sells a property, the gains are taxed at income tax rates not CGT rates. So tax will be 20%, 40% or 45% depending on one’s other income, not 18% or 28%. By contrast, if an investor sells their property down the line, CGT rates will apply. Generally speaking, the advantages of incorporating are greater for a property trader than for a property investor.
2. Company vs. Individual – Instead of buying property as an individual one could consider purchasing property through a company. There are advantages and disadvantages to this approach. For companies, rent and gains are both subject to Corporation Tax (currently 19%). If money is then extracted from the company by means of a dividend income tax is due at 7.5%, 32.5% or 38.1% depending on ones other income.
3. Interest Only vs. Capital Repayment – A common strategy in years gone by was to purchase a whole host of properties with interest only mortgages. The rent coming in was sufficient to pay the interest and provide passive income. The Government, however, decided that this was pricing first time buyers out of the market so put in place rules to cap relief that landlords can claim for interest payments. Such rules can considerably increase the tax burden for landlords owning personally:
By contrast, companies can still claim relief in full for interest.
4. Regular Rental vs. Furnished Holiday Let – Special rules apply if one is renting, “Furnished Holiday Lets (FHLs).” As the name suggests, these are furnished properties let out on a short term basis (for full conditions see HMRC’s guidance note). There are significant tax benefits to being an FHL, including the ability to claim Capital Allowances and CGT relief such as Business Asset Disposal Relief. Profits from FHLs also count as pensionable income, potentially increasing the amount you can pay into a pension each year.
5. Immediate Profit Extraction vs. Reinvestment – There are two approaches when it comes to buy to let properties. One is to buy a property, or two, with the aim of spending the profits. The other is to reinvest the profits into buying new properties. Generally speaking, the second approach favours incorporating. This is because with Corporation Tax at just 19% one still has 81% available to buy new homes post tax. By contrast, with Income Tax potentially as high as 45% one only has 55% left to reinvest. As a result, even if profits are completely equal, the corporate landlord may be able to scale more quickly than the individual landlord.
Of course, this rationale depends a lot on individual circumstances. For the basic rate taxpayer, who would have 80% to reinvent, incorporating just to up this to 81% makes little sense.
6. New Property vs. Former Residence – There is generous Capital Gains Tax relief when individuals dispose of former main residences. This can reduce the CGT payable substantially, often to nil. Individuals also pay no tax on the first £12,300 of gains they make each tax year. Such relief is not available to companies. As such, generally speaking, it tends not to be beneficial from a tax perspective to hold current or former residences within a company.
7. Stamp Duty Land Tax (SDLT) & Annual Tax on Enveloped Dwellings (ATED) – Whenever properties are being purchased, Stamp Duty Land Tax needs to be considered. Acquainting yourself with reliefs such as Multiple Dwellings Relief can save you significant sums of money where, for example, you buy a block of flats or a home with a separate, “granny flat” or annex. Similarly though there are traps for the unwary. Say you buy a house through a company and, two years later, decide to rent it out to a close relative. In these circumstances, you could be facing a 15% punitive SDLT rate on the full value of the property. For an average home, valued at £268,000, that’s an extra £40,200 bill that would need to be found!
ATED is another tax frequently overlooked. It is due where a company owns a single dwelling worth in excess of £500,000. Exemptions are normally available for businesses but the exemption needs to be claimed – there is still admin to do. Additionally, renting out a home to a close relative can invalidate the exemption and trigger an ATED tax charge.
8. Inheritance Tax (IHT) – Property investment businesses rarely qualify for inheritance tax relief. As such, if the owner of a large property investment company were to die, the full value of the company could be exposed to tax at 40%. Operating a company offers some advantages in mitigating against this though. By passing on shares in the business during one’s life, one can pass on a portfolio to a number of descendants in a very flexible way. This reduces the value of the estate at death and in so doing can save a considerable tax bill.
9. VAT – Simply buying a property and renting it is usually straightforward – no VAT on purchase, no VAT charged to the tenants (provided the seller has not opted to tax the property). However, if the plan is to refurbish, convert, develop, extend, demolish, etc. the VAT implications can get very complex, very quickly. If one employs contractors to help develop property, there is also the Construction Industry Scheme (CIS) to think about. If one’s plan is to derive substantial levels of passive income from property, it is important to understand the VAT implications to make sure you’re not caught out.
10. Where is the business based? – Generally speaking rules regarding income tax, CGT and corporation tax are broadly the same across the UK. However, corporation tax in Northern Ireland is currently just 12.5% rather than 19% for the rest of the UK. Scotland and Wales also have their own alternatives to Stamp Duty Land Tax which, while following the same broad principles, are subtly different. Property law in Scotland is also quite different to England, with implications for buying, selling and managing property portfolios. If you’re open to buying property anywhere in the UK, it’s worth considering the pros and cons of the various devolved legal systems.
Financial independence is a fantastic objective. If you have a plan to get there but are worried about the potential tax pitfalls, please don’t hesitate to get in touch with us. For additional information regarding incorporation more generally, check out our article – Should I Incorporate?