Tag Archives: Income tax

Income tax issues with ownership of rental properties

The reality is that many married couples are liable to very different rates of income tax. It is not uncommon to have one who is a 40% payer while the other is liable only at 20% or has no liability at all. Therefore you might think that there would be some mileage in arranging property affairs to take advantage of this.

It is of course conceivable that the person with the higher level of income could be a 50% payer but most people in this position would and should already be arranging their tax affairs appropriately. Where one spouse is just into the 40% band, perhaps these issues would not have been addressed.

In a joint tenancy we said previously that the interests in the property are indivisible. Any profits from renting would be shared fifty-fifty which could be distinctly disadvantageous if there were a significant disparity between the highest marginal rates of the individual owners.

Married couples owning rental property as tenants in common will normally be assumed by HMRC as sharing their profits (or losses) fifty-fifty even if they actually own the property in different proportions. If the ownership percentages are in reality different, the split can be applied to the apportionment of income between the two, but that split must reflect each spouse’s share. A formal election form needs to be completed in these circumstances.

Without an election, if one spouse who wholly owns a property transfers a very small share of a per cent or so to the other, HMRC would make a fifty-fifty split automatically. This would save the couple jointly a significant amount by moving half the income from perhaps the donor spouse’s 40 or 50% tax band to the recipient’s 20 or even 0% tax band.

People who are not married or in a civil partnership may own property as joint tenants in any respective proportion such as seventy-five twenty-five, but may split the rental income in a different way they have agreed between them, preferably in writing, if they have a disparity in their particular tax rates. Of course they may do this without regard to income tax tax, but the point is that they have considerable flexibility. For capital gains tax purposes, gains will follow the underlying beneficial ownership as outlined.

You will see that it is possible to arrange your affairs in order to reduce the tax burden on a common sense way and without resorting to any scheme HMRC might not like. This does not mean that it is necessarily straightforward to do so as issues outlined here and in the previous article have to be considered carefully. You should seek professional advice before taking action.

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Property taxation for smaller investors and developers

Recently I have written posts on Furnished Holiday Lettings and on the new Capital Gains regime. Such is the enthusiasm for property investment and development even in these troubled times (and I share that interest myself) that I thought I should write a brief summary of the taxation implications of these interests and activities.

Property still offers the prospect of profits and long-term investment gains at a time when share markets are uncertain and yields on savings are generally poor. TV programmes such as Homes under the Hammer and Property Ladder are very popular and while there is no pretence that there is an easy way to make a fast buck it is clear that many people do make a reasonable profit by putting their money and often their labour into improving and refurbishing houses, flats and even commercial premises. What is rarely discussed on television is the taxation aspect of these activities.

UK taxation law looks at the nature of the property activity in order to determine the basis of taxation. Of course there are from time to time grey areas, but I will endeavour to explain the distinctions as clearly as I can.

In Homes under the Hammer we tend to have two types of approach in terms of those who buy their new property at auction, the investors and the developers.

Property investors

Many people buy with a view to refurbishing and letting their properties. Therefore there is clearly a view to long term investment. These people will expect to pay income tax at their appropriate rates on their lettings profits, which are the excess of their rents received over the running costs and expenses, which would include repairs and re-decoration, any utility expenses paid by the landlord, insurance, mortgage or finance interest and any other maintenance to be undertaken by the landlord.

The rates of income tax on profits could vary from the basic rate of 20% to 40% or even 50% for those on incomes over £150,000. As they are holding their properties to receive an income stream they are true investors. When they sell their properties after holding them for a period, their investment profit will be subject to capital gains tax at the rates of 18% or 28% as appropriate on gains realised after 22nd June 2010.

Property developers

Others are expecting to improve and sell on their properties as soon as they are ready. These people are carrying on a trade as property developers and will pay income tax on their profits from sale rather than capital gains tax. If they are not trading through a company then they will also be liable to Class 2 and Class 4 National Insurance, the latter being income related, and remember that “income” means their profits from buying, refurbishing or re-developing and selling on.

The difference in the basis of taxation from the investors who hold their properties is really one of intention. A habitual practice of property improvement and sale is likely to be seen as “an adventure in the nature of a trade” as the tax parlance has it. The intention is to make money usually over a relatively short term. Case law says that even one deal may amount to carrying on a trade if there is a clear intention towards profit from that deal. Many of the scenarios seen on the television programmes involve “amateur” property developers buying a flat or house, doing it up and / or converting it and selling it on. This will amount to trading. The profits will be subject to income tax and NIC rather than capital gains tax and consequently will be taxed more highly. Deductible expenses will include not only the cost of the refurbishments and other building works, but also any mortgage or finance payments. This should be contrasted with the investors who may claim finance costs only against letting income and not against their capital gains.

Because of the relatively high taxation rates which may apply to profits realised by developers subject to income tax they may decide to operate through a company. It is possible to cushion the effects of taxation a little using a corporate vehicle and it might be appropriate for even quite small scale developers, but I would always recommend seeking professional advice before taking this route. It is a complex area and now is not the time to explore it.

Grey areas

Now and again the differences between investment property management and property development may be blurred. Sometimes a would-be developer may decide to let the refurbished property while awaiting an improvement in the market and such a situation would look less like trading and more like investment. It could be that an intending investor repaints a garden flat, tidies up the garden and then before it is rented out gets a really good offer to purchase which is too good to turn down. To make a judgement over tax treatment will depend on the facts and in some cases a good argument.

Other complications

Unless operations are on a very large scale, generally our developer on the TV model will not have to worry about the onerous requirements of deducting tax paid to subcontractors under the Construction Industry Scheme, but before diving in it is always worth getting professional tax advice.

There are other taxes involved in residential property, notably Stamp Duty Land Tax (SDLT) on purchase of any real estate and if you are selling you might consider the advantages of looking for first time buyers who currently have advantages in terms of having higher thresholds before paying SDLT.

Purchase price SDLT rate SDLT rate for
first-time buyers
Up to £125,000 Zero Zero
Over £125,000 to £250,000 1% Zero
Over £250,000 to £500,000 3% 3%
Over £500,000 4% 4%

From 6th April 2011, the rate of SDLT on properties valued at over £1M is 5%, but that will not concern most smaller-time property investors.

Summary

The property market is still “hot property” with promise of real rewards. The tax implications are quite complicated, but not too difficult to pick through with proper professional advice. Why not give us a call?

© Jon Stow 2010, 2011

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