Personal
Tax
Tax
Aspects of Property Investment
Investment
in property has been and continues to be a popular form of
investment by many people. It is seen as a route by which:
- relatively
secure capital gains can be made on eventual sale
- income
returns can be generated throughout the period of ownership
- mortgage
finance is covered in repayment terms by the security of
the eventual sale of the property and in interest terms
by the rental income.
Of
course, the net returns in capital and income will depend
on a host of factors. But on the basis that the investment
appears to make commercial sense what tax factors should you
take into account?
This factsheet summarises the main tax issues.
Who
or What Should Purchase the Property?
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An
initial decision to be made is
- as
an individual
- as
joint owner or via a partnership (often with a spouse)
- via
a company.
There
are significant differences in the tax effects of ownership
by individuals or a company.
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Which is the best medium will depend on a number of factors
but if the property is commercial rather than residential,
the likely answer is that the investment is made as an individual
or as a joint owner.
Commercial
Property
The
current capital gains tax (CGT) regime makes personal investment
in commercial property a potent source of tax savings.
Since April 2000, a sufficient condition for ‘business
assets taper relief’ to be due on eventual sale of a
commercial property is that the property is used in the trade
of an ‘unquoted trading company’. Indeed from 6
April 2004 relief is also due where the property is used in
the trade of an unincorporated business.
Where the maximum amount of business assets taper relief is
available, 75% of the capital gain is removed from the charge
to tax and therefore the maximum CGT rate applying would be
10% (assuming that the top rate of tax in the year of disposal
is 40%).
So in the following scenarios, there would be a low tax rate
on a gain if:
- you
own a property which is used by your trading company
- your
(prospective) tenant is trading as an unquoted company/unincorporated
business.
You
are currently trading as a limited company
The personal purchase of new offices or other buildings and
the charging of rent for the use of the buildings to your
company is very tax efficient. In addition to the low CGT
rate compared to corporate ownership:
- the
rental you receive from the company allows sums to be extracted
without national insurance
- the
company will claim a corporate tax deduction for the rent
- finance
costs will be deductible from the rents
- the
net sale proceeds will be received in your hands (and not
the company’s).
An
alternative route would be to have a company pension scheme
owning the property. In this situation, the rental would be
tax free in the pension fund (but then there would be no relief
for the financing costs).
Your prospective tenant is trading as an unquoted company
The same benefits as described above are also applicable.
The company using the property does not have to be your company
or, indeed, one with which you have any connection other than
through the landlord/tenant relationship.
This also means that, if you are currently trading as a limited
company, it is possible for your spouse to have a joint interest
in the property (or own it entirely) without prejudicing CGT
business assets taper relief.
But note that you do need the right type of tenant otherwise
the maximum taper relief would be 40% (giving an effective
top CGT rate of 24%) and that is only available after ten
years of ownership. Currently the tenant needs to be either
an unquoted trading company or an unincorporated business
to qualify.
Residential
Property
The
decision as to who should own a residential property to let
is much more evenly balanced.
The answer will be dependent on the following factors:
- do
you already run your business through your own company?
- how
many similar properties do you want to purchase in the future?
- do
you intend to sell the property and when?
Do
you already have a company?
If you already run your business through a company it will
generally be more tax efficient to own the property personally.
This will enable you to have the benefit of taper relief of
40% after ten years ownership and use of your CGT annual exemption
(and spouse’s annual exemption if jointly owned).
The net rental income will be taxed at your marginal rate
of tax, but if you are financing the purchase with a high
percentage of bank finance, the income tax bill will be relatively
small.
In contrast, the company has an indexation allowance to reduce
the capital gain. This effectively uplifts the cost of the
property by the increase in the Retail Price Index over the
period of ownership. So this may, or may not, give less relief
over the ten years.
But there are other factors to consider:
- there
may be a further tax charge should you wish to extract any
of the proceeds from the company
- inserting
the property into an existing company may result in your
shareholding in that company not qualifying for business
assets taper
- if
you form another company to protect the trading status of
the existing company, that may increase the corporation
tax bill on your trading company (because of ‘associated
company’ rules).
If
you do not have a company at present
Personal or joint ownership may still be the more appropriate
route due to the CGT taper advantages but there are currently
significant other advantages of corporate status particularly
if you expect that:
- you
will be increasing your investment in residential property
and
- you
are unlikely to be selling the properties on a piecemeal
basis or
- you
are mainly financing the initial purchases of the property
from your own capital.
If
so, the use of a company as a tax shelter for the net rental
income can be attractive.
Use of company as a tax shelter
Profits up to £10,000 benefit from the 0% corporation
tax starting rate. Profits between £10,000 and £50,000
benefit from marginal relief, whilst profits between £50,000
and £300,000 are taxed at 19%. These rates apply for
trading companies or property investment companies.
From 1 April 2004, the benefit of corporation tax rates below
19% where profits are below £50,000 is only available
where profits are retained within the company. A new regime
imposes a minimum 19% corporation tax rate where profits are
taken out of the company as a dividend.
Where profits are retained the income may be suffering less
than half of the equivalent income tax bills. That means there
are more funds available to buy more properties in the future.
Tax efficient long-term plans
There are two potential long-term advantages of the corporate
route for residential property which mitigate the disadvantage
in losing taper relief on the disposal of properties:
- is
there an intention to sell the properties at all? or
- can
the shares be sold rather than the property?
Using
the company as a retirement fund
A potentially attractive route is to consider the property
investment company as a ‘retirement fund’. If the
properties are retained into retirement, it is likely that
any initial financing of the purchases of the property has
been paid off and there will be a strong income stream. The
profits of the company (after paying corporation tax) can
be paid out to you and/or your spouse as shareholders.
To the extent that the dividends when added to your other
income do not exceed your personal allowances and the starting
and basic rate bands (just over £36,000 currently),
there will be no income tax to be paid.
Selling the shares
The advantages of taper relief can still be achieved if the
shares in the property investment company are sold (after
ten years of ownership) rather than the properties.
This may also be more attractive to the purchaser of the properties
rather than buying the properties directly, as they will only
have 0.5% stamp duty to pay rather than the potentially higher
sums of stamp duty land tax on the property purchases.
Other recent tax changes – stamp duty land tax (SDLT)
SDLT which replaced stamp duty from 1 December 2003 is payable
by the purchaser and is a flat percentage of the consideration
paid (up to 4%).
If the property is in a ‘disadvantaged area’ (see
www.inlandrevenue.gov.uk/so
for further details) there is no SDLT on residential properties
where the consideration is £150,000 or less and no SDLT
at all on any commercial property.
How
We Can help
This
factsheet has concentrated on potentially long-term tax factors
to bear in mind.
You need to decide which is the best route for you to fit
in with your objectives. We can help you to plan an appropriate
course of action.
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For information of users: This material is published
for the information of clients. It provides only an overview
of the regulations in force at the date of publication, and
no action should be taken without consulting the detailed
legislation or seeking professional advice. Therefore no responsibility
for loss occasioned by any person acting or refraining from
action as a result of the material can be accepted by the
authors or the firm.
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