Classifying your Property Business
The first thing you need to determine is 'what type' of property business you are. This is essential as the tax treatment is different depending on the activities your property business is involved with.
Generally, you could classify your property activities under one of these four categories:
- Property Investment (property letting)
- Property Development
- Property Trading
- Property Management
Property Repairs and Tax
The latter three activities are classed as a 'trade'
by HMRC and so are subject to Income Tax and National Insurance rules. Property Investment is not
classed as a trade by HMRC and so when you come to sell the properties any profit will be subject to capital gains tax.
Individuals running a property investment business will be subject to much lower rates of tax than a property trading business when they come to sell their properties. Capital gains are taxed at a rate of just 18% for basic taxpayers (20% for property traders) and 28% for higher rate taxpayers (up to 62% effective rate for property traders). In addition to this, a capital gains tax 'Annual Exemption' of up to £10,600 is available each tax year for an individual.
It is not as simple as just saying
I am a property investor or
I am a property developer. Many property businesses have mixed status depending on different projects they are involved with. In addition to this, if you held property for investment purposes but wanted to make a quick sale to realise a substantial gain it would not necessarily make you a property trader. Care must be taken to classify your business correctly.
Property Investors (Landlords)
Property investors hold properties as long-term investments, producing income in the form of rental profit and capital growth. The rental profit is subject to income tax (not national insurance) and as mentioned earlier any capital gain on sale of the properties will be subject to capital gains tax. You can get a deduction against profits for a number of different types of expenses you incur when carrying out your property business. However, you must make sure that these expenses are correctly classified as either 'revenue' or 'capital'.
Tax Allowable Property Expenses
- Travelling - you can get relief for travelling to and from your properties as long as it is for business purposes.
- Accountancy and legal costs - most costs are allowable as soon as incurred. But if you run a property investment business, any expenses incurred with the purchase or first letting of the property will be a capital expense and have to be added to the 'base cost' of the property.
- Mortgage Interest - is allowable and may be claimed against rental income if it is incurred for the purpose of the property business. In addition to this, interest relief should always be available on any borrowings against a rental property up to its original value when first rented out. It does not matter what the borrowed funds are used for!!!
- Refurbishment - These have always been allowable for any rental or trading business. The key point here is to distinguish between'revenue' expenses and 'capital' expenditure. Only the firstof these can be offset against your rental income, as thelatter is treated as part of your base cost for capital gainstax purposes. Generally a repair will restore an asset to a condition it previously was where as capital expenditure will improve it in some way.
Examples of common repairs that are normally deductible in computing rental business profit include:
- Exterior and interior painting and decorating
- Stone cleaning
- Repairing broken windows, doors, furniture andmachines such as cookers
- Pre 'Trading' Expenditure - You can claim a tax deduction for expenses incurred up to seven years before you start your property business. So if you incur any expenses setting up the letting make sure you claim them.
- Other Common Property Expenses include:
- Bank Fees
- Wages & Salaries
Please note this is not a definitive list but should give you some good ideas.
As mentioned earlier, a property trading business is subject to much higher rates of tax than a property investment business (Income Tax & National Insurance). One option for a property trader to reduce taxes is to operate the business through a Limited Company.
Limited Companies are subject to Corporation Tax at much lower rates of tax than sole trader businesses. Profits made in a financial year are currently taxed at 20%.
The drawback to using a Limited Company is that care must be taken to ensure you are not taxed again when profits are drawn out of the business. Profits drawn out as a salary over and above you personal allowance (£10,600 for 2015/16) will again be subject to Income Tax and National Insurance. It will depend on other income received in the year, but the majority of any profit withdrawn from the Company should be done so as a dividend.
Basic Rate taxpayers pay an effective rate of 0% Income Tax on dividends paid out by their property business. Higher Rate taxpayers only pay an effective rate of 25%. In addition, dividends are not subject to National Insurance and so substantial savings may be made. There is also scope to pay yourself a small director salary and use your spouse's tax free bands.
Please seek professional advice to ascertain all the benefits of using a Limited Company for you and your property business.