Alan Pink looks at a few ‘real life’ solutions to the problem of tax and property sales.
Capital gains tax (CGT) is a big threat to the financial health of a property investment business. In overview, CGT is a tax which bites when certain types of assets are disposed of at a value higher than they were acquired for. The most common assets that are subject to the tax are property, shares in companies, and assets used for the purposes of a business.
The rate at which CGT is charged depends on the individual’s level of income (companies pay corporation tax on their gains). So, for a higher rate taxpayer, commercial property gains are charged at 20% and residential property at 28%. The equivalent for lower rate taxpayers of these two rates are 10% and 18% respectively, but these lower rates are actually of very little relevance in practice because the gain itself, unless it is very small, is likely to push the individual into the higher rate category.
Capital losses are offset against gains made in the same tax year, and any excess losses are carried forward. There is a small annual exemption above which gains are taxed. The main reliefs from CGT are business asset disposal relief (BADR) (for trading businesses, giving a 10% tax rate), rollover relief for trading assets, main residence relief, and enterprise investment scheme (EIS) deferral relief.
Reducing property CGT
Probably the best way to illustrate the sort of things that can be done is to set out some real life (or quasi-real life) examples. What follows doesn’t, of course, exhaust all possible avenues of CGT planning; it would take a book to do that! But it does highlight some of the more common ways in which you can blow a substantial hole in your CGT liability.
Example 1: Forgotten ‘losses’
Steve has just sold a buy-to-let property realising a gain of £100,000. Because of other gains he has made in the year, it will be taxable at 28%. So he goes to see his accountant to find out if there is anything he can do to reduce this £28,000 liability.
After a conversation with the accountant, he finds in his loft details of a company he invested in 30 years ago which went ‘belly up’. It turns out that, with loans and shares combined, he lost over £100,000 in that venture, and it’s never been claimed. He also finds rummaging around amongst his old papers, details of the £50,000 he lost on an equally unsuccessful investment in 1999. He triumphantly takes those back to the accountant.
The accountant tells him that the loss from 1991 can be claimed, because it arose before self-assessment. By duly claiming the loss (and being willing to substantiate it with paper evidence if HMRC ask) he can eliminate the tax on the property disposal. The £50,000 he invested in 1999 and lost is an absolute dead loss, though. Following the introduction of self-assessment on 6 April 1996, losses had to be claimed within a strict time limit.
As well as losses made in the dim and distant past, of course, there may be assets you currently own which are worth less than they cost to buy. By managing a disposal of such an asset within the same tax year, you can crystalise the loss and make it available for offset.
Example 2: Rollover relief
Bertha has been running the Stitch In Time pub for many years, and finally gets fed up with the way the breweries treat her. She sells the pub to a developer who has planning permission to turn it into umpteen flats. So the gain is quite large and, even though she gets BADR there is still quite a chunky CGT charge to pay.
A couple of years later, she spots an attractive house in the Lake District and decides to buy it. The house is taken into use providing furnished holiday accommodation when she acquires it, and this enables her to claim rollover relief.
Under rollover relief, the gain made from selling one trading asset can be offset against the base cost on acquiring another trading asset (of which furnished holiday accommodation is a special example). The result is that the tax is not payable on the disposal of the first asset. So Bertha gets a very nice tax refund, along with the Cumbrian property.
Bear in mind that rollover relief is available not just for new assets acquired up to one year before and three years after the gain on the first asset, but is also available against improvement expenditure. So if Bertha had already held the furnished holiday property, but decided to spend the proceeds from the pub in massively extending and improving it, relief could have been claimed against that as well.
Main residence relief
CGT main residence relief can also sometimes be organised to be available. But beware of a policy of what might be called ‘serial main residence occupation’.
You probably know the sort of thing; the builder who buys a rundown property, fits it out beautifully and extends it, then sells. He then moves on to another, and so on, selling a ‘main residence’ every year. You might possibly ‘get away with this’ for a few years, but HMRC are within their rights (if they see what is happening) to claim that you are really, in effect, trading in properties and therefore should be paying income tax, so no CGT main residence relief.
Example 3: Furnished holiday accommodation
Peter foresees a gain on a property, but in his case there is no possibility of his using the property as even an occasional residence. He is worried about the amount of tax that will be payable on the sale of a house in Bournemouth. So he turns it into furnished holiday accommodation, and runs it as such for the qualifying two year period.
In consequence, because furnished holiday accommodation is treated as a trade, he gets BADR, reducing the tax rate from 28% to 10%.
Note that this applies even if the property has been held for many years and not qualified as furnished holiday accommodation until the last two years or so.
Example 4: Incorporation relief
Mary and Christine jointly own a substantial property portfolio, which takes a lot of their time to run. They foresee selling the whole portfolio, or at least the lion’s share of it, in the near future, in order to reinvest in commercial property, which they are much more keen on as their active years decline. Transferring the whole portfolio into a limited company gives the availability of ‘incorporation relief’ from CGT, and this is how it works.
On the basis that the portfolio can reasonably be described as a ‘business’, the gain by reference to the value of the properties is computed, then deducted against the deemed base cost of the shares. So if Mary and Christine sell their shares in the company later, this gain will crystalise and tax would be payable. But for the company, it is treated as having acquired the property portfolio at its current market value. So when the portfolio is sold shortly afterwards for a similar figure there is no tax to pay. The money is then reinvested in a commercial property portfolio within the same limited company.
If Mary and Christine had wanted to spend the proceeds from selling their portfolio on private matters, like buying a bigger house or paying off a home mortgage, or even going on holiday, the incorporation relief idea isn’t quite so clever, because tax would be payable on taking the money out of the company in order to do these things.
All of which leaves us with no room to talk about EIS deferral relief; but that deserves an article by itself (memo to Editor…)!
