Timing Can Be The Difference Between Higher And Lower Property Taxes

Julie Butler outlines the importance of timing property transactions in order to maximise tax savings and explains the need to plan in advance for all areas.

It has been said that ‘timing is everything’.  Most property taxpayers want to pay a fair and reasonable amount of tax.  However no taxpayer wants to pay ‘silly tax’ (i.e. tax created through bad timings or inefficient structures).  Examples would be to pay a higher rate tax one year and then pay no tax the next year due to (say) tax losses.  The essential ingredients to all-efficient tax savings is the combination of good housekeeping and planning in advance.  The problem with this philosophy is that most taxpayers fail to organise their property affairs in this way!

With each individual taxpayer having an annual exemption for capital gains tax (CGT) purposes (£10,900 for 2013/14) there is effective tax planning that can be put in place to ensure that CGT savings are maximised by spreading property disposals across the tax years.

The standard rate of CGT is 28% but this is reduced to 18% on capital gains up to the unused amount of the basic income tax band, if any.  There is therefore an additional benefit to selling the property when taxpayers are lower earners. 

Obviously property disposals should be protected by PPR where possible.  The timing of the disposal of the main residence must also be looked at for tax advantages.  There was a blow for property owners in the Chancellor’s autumn statement in December 2013 with the announcement of a reduction in the ‘tax free’ time allowed to sell the main residence after ceasing to live there.  Each individual had a period of three years after moving out of the main residence to sell the property and still achieve PPR.  The Finance Act 2014 is to reduce this time allowed to 18 months, effective from 6 April 2014.  Previously the property owner could play with this three-year allowance and reasonably enjoy extra tax-free allowances.  

Care has to be taken to maximise the use of PPR and above all the timing of the disposal of the main residence. Advantage can be taken of ‘flipping’.

‘Flipping’ broadly involves a taxpayer electing for a second home to be his or her main residence for CGT purposes (TCGA 1992, s 222(5)), then changing that election in favour of the first home a short time later.  The ’short’ period should ideally not be ‘ridiculously short’ and there should be a degree of permanence, with which to substantiate the ‘quality’ of occupation.

By this procedure, the first home loses the main residence exemption for (say) a few weeks, and the second home achieves at least three years’ worth of exempt gain.  As mentioned, this period is reduced to 18 months from 6 April 2014.  However, to be effective, both properties must be factually occupied as the taxpayer’s home, and the deadlines for making and changing the election must be achieved.  It is essential that there is evidence of actual occupation.

It is generally only farmers who are allowed to ’average’ their profits.  Landlords can, however, prepare budgets and predictions of future expenses to even out the tax disadvantages of unpleasant fluctuations.  A five-year plan of expenditure for both repair and improvements should be carried out.  In the current tax regime property owners don’t just have the worries of the ‘higher rate threshold’, but also the 45% additional tax rate.  For 2013/14, this higher rate threshold is £41,450.  This is the level of income after which taxpayers begin to pay the 40% higher rate of tax above the personal allowance (PA) i.e. it is the sum of the PA (£9,440 for 2013/14) and the basic rate limit (£32,010 for 2013/14).

There is the further disadvantage of a 45% tax rate for earnings above £150,000.  Clearly the tax planning has to be tailored towards what level of income the property owner enjoys.  There must be consideration for other variable income sources (e.g. dividends drawn from owner managed businesses).  Timing the point at which property expenses are incurred can help keep total income below these problem levels.  It is not just repair expenses that can be controlled by strategy month on month and year on year.

Where an individual’s net income exceeds £100,000, the personal allowance (PA) will be reduced by £1 for every £2 of income above £100,000, i.e. there is an ‘abatement’ of the personal allowance.  Where total income for a tax year is predicted to rise above £100,000, tax planning can be brought into play by increasing property repair expenditure to keep below the £100,000 limit.  There are many taxpayers unaware of this ‘tax nasty’ and many fail to realise how painful the ‘tax hit’ is with income just above the £100,000 limit.  Tax planning suggestions are the obvious pension contributions and gift aid, as well as the timing of property expenditure.

As mentioned, for 2013/14 the PA is £9,440.  It is easy to see how punishing the abatement of the PA can be and how helpful the correct timing of expenditure is.

There have been three recent tax tribunal cases that have helped the case for claiming expense incurred on property maintenance as repairs as opposed to improvements, thus accelerating the absolute tax relief, not just the timing of the tax relief (see Property Tax Insider December 2013).  The three cases are Pratt (G Pratt and Sons v HMRC [2011] UKFTT 416 (TC)), Hopegar (Hopegar Properties Ltd v HMRC [2013] UKFTT 331 (TC)) and Cairnsmill Caravans (Cairnsmill Caravan Park v HMRC [2013] UKFTT 164 (TC)) and there are tax advantages of understanding the principals of these cases.  The preparation of a five-year projected property repair and improvement schedule should include reference to these cases.  Evidence to support the claim for repairs must be made.

A projection of every tax return must be prepared in advance so it can be seen which higher tax rates the taxpayer/property owner needs to be saved from.  This must obviously be tied into projected repair and improvement schedules.  Each tax return must be prepared as soon after the end of the tax year as possible, but by then we are dealing with historic information.  

It is possible to assign property income between spouses (see Property Tax Insider February 2013).  Thus if one spouse is a higher earner it is possible to assign the property income to the lower earner.  Such activity must be undertaken as part of the overall tax planning review.

Income tax trading losses can be offset ’sideways’ against total income and also against capital gains in order to achieve tax relief, within certain limits.  There are therefore judgement calls to be made about how and when the trading losses should be offset.  Trading tax losses can become a useful planning tool to keep below the higher rate threshold.  There can also be planning around the trading loss with regard to the timing of trading expenditure (e.g. when a higher tax loss is needed there has to be planning of the expenditure).

Tax planning around property taxes is not simple, it is not one dimensional, and it cannot be undertaken historically or lightly.