Previous booms in the housing market served to boost the popularity of investing in property. Despite the recent slowdown, many people are finding that the value of their home means they are liable to taxes such as inheritance tax (IHT).
Property ownership has a number of different tax implications, which is why it is essential to put in place adequate tax planning measures now. This guide sets out some of the key aspects of tax and your property.
Your home and capital gains tax
Your main residence is exempt from capital gains tax (CGT) when you sell it, provided it has been your only or main residence during the whole period of ownership (or since 31 March 1982). Various rules allow periods of temporary absence to be disregarded.
Owning more than one property
If you have more than one home, you may elect which is to be your main residence (i.e. exempt for CGT) within two years of acquiring the additional residence. As long as a home has at some time been your main residence for CGT, the last eighteen months of ownership added to your exempt period.
It may be beneficial for a married couple to own the non-exempt residence jointly as each will be entitled to the annual capital gains tax exemption.
Partial business use
If you use part of your home exclusively for business, interest on the relevant portion of the borrowing will be allowed as a business expense. In these circumstances, a similar proportion of the CGT exemption will be lost. However, if you use no rooms exclusively for business purposes, the full exemption will normally be preserved.
Tax relief is not normally available on loans used to buy your home.
Tax aspects of property investment
Income arising from land and buildings is generally treated as investment income unless it is from furnished holiday lettings or from property development, or the provision of services such as hotels and guest houses, in which case it would be classified as trading income.
From an accounting and tax point of view, all rental income (except furnished holiday lettings) is treated together as coming from one ‘property’ business, regardless of the terms of letting. Profits and losses are calculated using the same general accounting rules as for trading, including accruals to cover the timing difference of rent or expenses in advance or arrears.
Jointly owned property
Profits or losses arising from jointly owned property will normally be divided according to the share in which the property is owned. But joint owners can agree a different division of profits and losses. Each owner’s share for tax purposes must be the same as the share actually agreed.
Husband and wife, or civil partners, normally own joint property as “joint tenants”. This means that each has equal rights over the property and when one dies it goes automatically to the other. However, it is possible to change the ownership to “tenants in common” where the share of each is separate and may be disposed of during lifetime or on death as the spouse or partner wishes. Profits and losses are treated as arising to them in equal shares unless both entitlement to the income and the property are in unequal shares, and both partners ask their respective tax offices for their share of profits and losses to match the share each holds in the property. Form 17 is available to be used for this purpose.
Furnished Holiday Lettings (FHLs)
Property businesses which comply with the relevant conditions can qualify for some very important tax concessions. FHLs are treated for tax purposes as if they were trades. Unlike other domestic lettings, the expense can include capital allowances on furniture and kitchen equipment. The income counts as earnings for pension contribution purposes, and there are other advantages relating to the disposal of such properties.
Allowances and Reliefs
Expenses allowable in calculating income include interest incurred on loans used towards the purchase of the property (adjusted for any part private use), rents, rates, insurance, repairs, management and professional fees.
Expenses incurred when improving the property (such as extensions), or those which were necessary to bring newly acquired property to a useable state, all form part of the capital cost of the property.
Allowances for equipment
In general it is not possible to claim capital allowances for fixtures and fittings in a dwelling house. Landlords are able to deduct the actual costs of replacing furnishings in furnished properties. It is also possible to claim a deduction for the costs of renewal of fixtures, such as baths, toilets and washbasins.
For commercial properties, capital allowances may be claimed in respect of plant and machinery supplied by the landlord.
Rent a room relief
Under the ‘rent a room’ scheme, income from letting furnished rooms in your main residence will be exempt from tax if the gross annual rent does not exceed £7,500 (£3,750 if you share the income). If you are letting to lodgers who live as part of the family, there will be no loss of capital gains exemption. Otherwise, there may be some restriction.
Inheritance tax considerations
Unfortunately, the favourable concessions for the income tax and CGT do not extend to IHT. It has become very difficult for a person to give away property but still continue to occupy it. IHT planning is best directed at assets other than the family home – please contact us for further advice in this area.
Where there is mixed use of a property, business rates may be payable as well as council tax, unless the business use does not materially detract from the private use. Non-domestic properties, such as commercial premises and boarding houses, are in any event subject to business rates. Provision of bed & breakfast in your own house is not caught if there are no more than six guests. Staff accommodation is counted as domestic and therefore subject to council tax.
VAT on land and buildings is a complicated area. Generally sales of commercial buildings less than three years old are standard rated, sales of new residential properties are zero rated and most other sales or leases are exempt. The VAT provisions on property letting are particularly complex.
Stamp Duty Land Tax (SDLT)
There is no charge to SDLT if residential property is purchased for £125,000 or less, or on non-residential property for £150,000 or less. Property which is not exempt is charged at varying rates between 1% and 12% as appropriate.
If the purchase and sale of properties amounts to a trade then profits will be taxed as income in the normal way. In all other cases, disposal will be subject to the normal rules for the calculation of capital gains.
The situation may be complicated where a principal private residence has been let at some time during the period of ownership. In these circumstances, the associated lettings relief of up to £40,000 (£80,000 for a couple) could be brought into play. Furnished holiday lettings may also qualify for rollover relief or gift relief. In some circumstances they may also trigger IHT business property relief, in which case they would pass free of any IHT charge.
While some of the principles of property taxation may seem relatively straightforward, seeking professional help is essential. Call 01233 630000 to book an appointment with one of property experts.