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Property tax planning: Investor or dealer?

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13th Sep 2010
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Lesley Stalker outlines the key considerations for property tax planning in the current framework and why should you ask clients if they are an investor or dealer.

Over the years, our advice when buying property has varied according to the client’s tax position and funding availability at the time. Should investment property be bought personally or through a company? This is not a clear-cut position, although the availability of taper relief on the disposal of commercial property has in recent years favoured the purchase of this type of property personally.

Following the introduction of entrepreneurs’ relief the position altered as commercial property on which a market rate rental was received did not qualify for the relief, as it had for taper relief. Now after the change of government, it has altered again following the increase in the rate of CGT from 18% to 28% for higher rate taxpayers and it is therefore worth revisiting the position.

As always, each case needs to be evaluated individually, but one can apply a general rule of thumb when advising a client according to whether they regard themselves to be investing or trading in property. If they are investing, then the advice tends more commonly towards personal purchase and ownership, whereas if they are trading or dealing in property, making frequent transactions and re-investing any gains, it may be more beneficial to do this through a company.

There are two key tax considerations which affect the final decision-making between personal or company ownership, and which need to be balanced; these are loan interest payments and CGT.

Where properties give rise to rental income, the individual or company is deemed to be running a property rental business. Losses arising on any property rental can be amalgamated with profits arising on rental income from the same property business and hence there is an automatic offset of losses. Any excess losses are carried forward and offset only against future profits arising from the same property business. Note that where both UK and overseas properties are held, these form separate businesses, so that there is one property business for UK properties and one property business for overseas properties. Losses arising in one business cannot be offset against profits arising in another business. Furnished holiday lettings are not subject to the same restrictions but their treatment is not covered within this article.

Consideration 1: Losses arising by reference to loan interest
Interest payable on loans to buy land, or property which is used in a property business or to fund improvements or repairs, is deductible in calculating the profits or losses. This also applies where the properties are re-mortgaged to enable the owner to withdraw capital equal to the value of the property when it was first brought into the property business.

For individual owners the interest is a deductible expense, whereas for limited company owners the interest falls within the loan relationship rules. This is an important difference because:

  1. For individual owners losses arising due to loan interest which exceeds rental income can only be offset against profits arising from the same property business in the same or future years. If profits don’t arise and all the properties are sold, excess losses brought forward will be lost;
     
  2. For corporate owners, because any losses arising as a result of excess loan interest fall within the loan relationship rules, relief for such losses can be claimed as follows:
  • By way of group relief;
  • Against any other profits of the same period;
  • Against any interest income of the previous 12 months; or
  • Carried forward and set against total non-trading profits of later accounting periods.

The effect of this is that losses arising can be carried forward for offset against future capital gains arising on the disposal of property.

Consideration 2: Capital gains tax
Gains arising on properties owned personally will give rise to capital gains tax at a rate of 28% for higher rate taxpayers. In such cases, the only allowable relief is the annual exemption (currently £10,100).

Gains arising on properties owned by companies are chargeable to corporation tax, which from next April will be at a reduced rate of 20% for small companies. In addition, gains arising within companies also attract indexation allowance. Therefore where the proceeds of disposal are to be retained within the company for reinvestment and therefore there is no additional tax liability in extracting funds from the company, the rate of tax suffered will often be lower than that suffered by an individual owner.

Example
Property purchased January 2002       
Cost £250,000       
Sale proceeds July 2010 £400,000

  Owned personally Owned by small ltd company
Sales proceeds £400,000 £400,000
Less cost -£250,000 -£250,000
Indexation allowance to July 2010 = 0.290 n/a -£72,500
Chargeable gain £150,000 £77,500
Less anual exemption -£10,100 n/a
  £139,900 £77,500
CGT @ 28% £39,172  
CT @ 20%   £15,500

However, if the shareholder is a 50% taxpayer and wishes to extract the funds from the company by way of a dividend then the total tax suffered will be greater if the property is in company ownership. Using the same facts as above, the example below highlights the increased tax liability for property ‘investors’ who do not re-invest gains.

Dividend   £77,500
Less higher rate tax @36.11%   -£27,985
Total tax suffered    
CT  £15,500  
IT £27,985 £43,485

Therefore as the examples illustrate, the question of tax advice around property ownership remains complex and cannot be generalised. Tax legislation is forever changing and based on current rules, where a property investment is undertaken with a view to sale where the funds will be required, the calculations are likely to illustrate that personal ownership is preferable. However, for clients who intend to buy and sell property frequently, reinvesting the proceeds, and especially where they have considerable loan repayments, company ownership may well prove to be more tax efficient, at least in the short term.

Lesley Stalker is head of tax at Robert James Partnership.

 

Replies (3)

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By doctorwho
13th Sep 2010 22:19

Personal investment is difficult for directors/shareholders of small cash rich companies with couple of millions sitting in company bank account. If they withdraw this to invest personally, 50% tax rate comes in force (dividends at approximate 46%) and they lose literally half of funds in paying personal tax, no matter they invest in property with an intention to keep investment or act as a dealer to buy and make quick gains. In this case investment through a company appears to be a best option for both intentions........ Well... What can be disadvantage for a cash rich company to invest in properties? Specially it will have opportunities to offset rental losses against other profitable trading activities I.e legal services......

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By gbuckell
14th Sep 2010 13:54

Not so close

If the profit is extracted as a dividend in the example, the required dividend is £150,000, not £77,500, making the company decidedly unattractive. Even if the company is liquidated rather than paying an income dividend, the tax will easily exceed the personal example.

An advantage of the company not made clear is the lower rate of tax on net rent which can be particularly attractive where the rent post tax is used to fund loan repayments or invest in other assets.

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By cfield
16th Sep 2010 11:25

Why not borrow the money from the company instead?

As you say, dividends are expensive now if you want to extract company profits to buy property, but there is another way. If you extract the funds as a loan, you could pay the company 4% interest to avoid a benefit in kind and claim that as an allowable deduction against the rent, so your own tax is minimised. Of course, the company would have to pay tax on the interest but it's a lot cheaper than borrowing the money externally. This is normally a good idea if you buy business premises for your company, as the rent will then be deductible against corporation tax. Plus it is usually a good idea to keep property in your own name rather than put it through a trading company so there is no danger of losing it if the company ever goes bust! The only downside is 25% tax on a participator loan, but at least you would get this back one day when the property or business is sold, whereas with a dividend the money is gone for good.

Chris

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