Tax Savings Opportunities for Buy-to-Let Properties and the Family Home
Following the move abroad of the cloth manufacturing industry, many members of the Greek community here in the UK have turned to the property development market (or buy-to-let market as otherwise known), especially. It is therefore a good opportunity to discuss some of the best tax planning opportunities associated with reducing taxes on:
- Renting or selling residential lettings.
- Letting the house where you live or part of it.
- Selling second homes.
Sale of rented property
Properties rented to traders (including your own private company) or used as furnished holiday lettings are the ONLY situations in UK tax legislation where lettings qualify on disposal (the term disposal includes sales but not only) for the very important relief reserved only for business assets under Capital Gains Tax. This amazing relief can sweep off up to 75% of the capital gain, thus resulting in only 5.5% capital gains tax (!), depending on certain conditions being satisfied (e.g. level of income and period of ownership).
Renting for the purpose of trade is a technical definition in tax legislation and therefore professional advice should be taken as it is very costly to reverse mistakes in tax planning.
Compare the above with the much less generous capital gains tax relief available to other lettings when disposed of. That ranges from zero to 40% off the gain (again depends on level of income and period of ownership). As you can gather, the taxman in general is much more generous to traders as opposed to investment holders because trading businesses carry more business risk in general and because Government - not surprisingly - wants to encourage new business. As a rule, lettings are treated as investments because they are held for their investment potential.
Because of the considerable tax advantages in the furnished holiday lettings described above, we are of the opinion that this area has been largely neglected or even ignored by investment property owners and more attention should be given to it, the reason being that, as we nave already mentioned, all tax advantages and reliefs given to proper trading businesses are available to this sector too.
Once again, before proceeding proper advice should be taken as the definition of furnished holiday lettings is technical.
Minimise profits (and taxes) from land and buildings
Normal repairs and maintenance expenditure are lax deductible expenses and can be set against income from rented property to reduce tax. The following are examples of allowable expenditure:
- Repair of a damaged area of a roof,
- Replacement of a kitchen with a kitchen of similar standard,
- Replacement of single-glazed windows with double-glazed windows,
- Replacement of central heating radiators, wash basins, sinks, baths, showers, alarm systems, carpets with like-for-like or with nearest modern equivalent.
In contrast, additions (i.e. when you add to the premises something that was not there before) or improvements expenditure is not an allowable expense against rentals and is treated as capital. The distinction between capital and revenue expenditure is a grey area and there have been several Court cases. The following are examples of not-allowable capital expenditure:
- building an extension,
- adding a porch,
- fitting a new kitchen of high quality expensive materials,
- adding an additional cabinet in the kitchen or bathroom
increasing the storage space {although apportionment on a reasonable basis required),
- Reconstruction of a roof that was in a very bad state that it could not be used or was in a state of disrepair.
As you know, when you buy business assets to be used in your trading business (e.g. equipment or vehicles), a percentage of the cost of those assets is deducted each year from taxable income to reduce taxes. But no such tax allowances are given on assets bought for your residential lettings business.
But, not everything is lost! By concession, an annual allowance equal to 10% of rent can be claimed. The 10% deduction is to cover furniture and furnishings and includes beds, curtains, linen, crockery or cutlery and blinds. Also, cookers, washing machines, dishwashers and refrigerators. Interestingly, it does not matter whether or not nothing was spent on furniture in the tax year in question; the deduction is still allowed!
Instead of claiming the above allowance, you can opt for a deduction for the actual cost of replacing a particular item of furniture or furnishings or machinery (note the word replacing, as it means you cannot deduct the cost of the original purchase). You probably don't renew items every year, meaning you won't get a deduction against rents every year.
Proceed with care as you cannot swap each year to what is your most favourable option in a particular year.
Moving on...
If you move in an investment property for a certain period, any gain you make on subsequent disposal will be completely exempt from capital gains tax for the period you have lived in plus the last three years of ownership.
Unfortunately there is no minimum in the law for which you have to live in the new property before you let it out and move on to another property which will be acceptable to the taxman as adequate to get you the exemption mentioned above. II very much depends on the facts of each case. There are some pointers though that can be used to establish main residence for tax purposes.
But, if you keep two residences during the same period, for the gain on the second home to be exempt from capital gains tax, you should inform the Inland Revenue that you want the second home to be treated as your private residence or the taxman will make the decision, not necessarily in favour of the taxpayer. Later on you vary the election to appoint back your first home as your private residence as you don't want to lose the exemption on that. It sounds pretty complicated but it works and it is definitely worth it.
Moving out...
If you move out and let your private home, for joint owners, up lo £80,000 of the gain attributable to the lettings period is potentially exempt from capital gains tax when the house is subsequently sold!
Of course, other capital gains tax reliefs and annual exemption will further reduce the capital gain. '''In many cases, the whole of the capital gain will be wiped off by the letting exemption!
So, what is the morale here?
Unless there are exceptional non-tax considerations for doing otherwise, the matrimonial home should be owned by the husband and wife jointly if at some time in the future the home is to be let out!
Be very careful...
Incorporating properly portfolios (i.e. transferring ownership of buy-to-let properties from you to your limited company) or buying a buy-to-let in the name of a company (as opposed to owning it personalty) can be an absolutely catastrophic nightmare scenario from a capital gains tax point of view, especially if thinking of selling in the foreseeable future.
Incorporating your property portfolio so as to take advantage of lower company tax rates on profits, is probable to result in huge capital gains tax bills for the owners of the properties at the point of transfer if the market values of the properties have increased since purchase.
This is because capital gains arising from revaluation of properties, which are being transferred to a company, do not qualify for any of the tax reliefs available to trading businesses (as already mentioned).
It would therefore be sensible, if a landlord does decide to go down that route, for the transfers to be effected piecemeal over different tax years if possible. That will ensure that at least, the capital gains tax relief available is maximised with time and that the annual capital gains exemption available to individuals is utilised for a number of years.
Constantine Savva
Chartered Certified Accountants
January 20, 2005
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Whilst every care has been taken in the preparation of this article, the author cannot accept responsibility for any errors or omissions. Proper professional advice should be taken at all times.
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