In this article our guest writer, Amer Siddiq, from Tax Insider will explain when to consider tax planning and the potential situations to consider.
A question you will most certainly ask yourself is ‘when should I consider tax planning for my property business?’
The short answer is “all the time”, but to be realistic, no-one is likely to do this. The trick is to develop by experience, a sense of when a tax planning opportunity (or a potentially expensive tax pitfall) is likely to present itself.
You should consider tax planning in all of the following situations, for example:
If you are buying a property, you need to consider:
- Buying the property – It could be you as an individual, you and your spouse, you and a business partner, a Limited Company owned by you, or perhaps a Trust you have set up. Your decision will depend on your future business strategy.
- Financing the property – You will need to consider whether you are taking out a mortgage, and if so how will it be secured. It may not always make sense to secure the loan on the property you are buying if you have other assets on which you can secure the loan.
Repairs and refurbishment
- Plans for the property – It could be that you are buying the property to sell it again in the short term, or to hold it long term and benefit from the rental income. The tax treatment will be different according to each case, and different planning should be done before the property is bought.
If you spend money on a property, you need to consider:
- Whether you are doing it in order to sell it again in the short term, or whether you will continue letting it.
- If the work being done is classed as a repair to the property, or an improvement.
The distinction between a repair and an improvement to a property is very important, because although the cost of repairs can be deducted from your rental income for tax purposes, an improvement can only be claimed as a deduction against Capital Gains Tax when you sell the property. Essentially, a repair is when you replace like with like, whereas an improvement involves adding to the property (say, a conservatory or a loft conversion), or replacing something with something significantly better (say, removing the old storage heaters and installing oil-fired central heating).
HMRC do not always behave logically when it comes to repairs versus improvements. James Bailey shares the following experience with us:
“A client of mine sold a seaside property, in circumstances where he would have to pay CGT on the sale profit. He had spent a lot of money on this property, which when he bought it had not been touched since the early 1950s. He had ripped out the old “utility” kitchen, for example, and replaced it with a state-of –the –art designer affair in gleaming slate, chrome, and steel. The old 1950s cooker had had some bakelite knobs to turn the gas on and off – the new kitchen range had the computer power of the average 1970s space capsule. Clearly an improvement, and so deductible from his capital gain, but HMRC tried to argue that one kitchen is much like another and he was just replacing like with like – so they said it was a repair, which was no good to him in his case as there was no rental income from which he could deduct the cost of repairs.”
When you decide to dispose of a property, there are other tax issues to consider:
- Who is the property going to? – If it is to someone “connected” with you, such as a close relative or a business partner, and if you do not charge them the full market value, HMRC can step in and tax you as if you had sold it for full value.
- Will you be paying CGT or income tax on the profit you make? – The planning opportunities are very different, depending on the tax is involved.
- What are the terms of the sale? Is it just a cash sale, or is the buyer a developer who is offering you a “slice of the action” in the form of a share of the profits from the development? There is important anti-avoidance legislation to consider if this is the case.
Whenever your life undergoes some significant changes, you should consider tax planning.
Here are some examples when tax planning should be considered:
- Getting married – a married couple (and a civil partnership) have a number of tax planning opportunities denied to single people, but there are also one or two pitfalls to watch out for.
- Changing your job - You may become a higher or lower rate tax payer and this may mean you should change your tax strategy.
- Moving house – it is usually not a good idea to sell the old house immediately as there are often tax advantages to keeping it and letting it out.
If you are moving house, and you sell the old residence, you will have the cash left after you have paid off the mortgage and the various removal costs to spend on your new home. If you need a mortgage to buy the new home, the interest on that mortgage is not allowed as a deduction for tax purposes.
If, instead, you remortgage the old house and let it out, ALL the mortgage interest you pay can be deducted against the rent you receive whatever you do with the cash you have released – and you may well be able to sell the house after three years of letting (or sometimes a longer period), and pay no CGT on the increased value since you stopped living there.
- Death – IHT is charged at 40% on the value of your estate when you die, to the extent that the value is greater than (for 2013/14) £325,000. By planning early enough it is possible to reduce the IHT burden considerably.
There are two occasions each year when you need to be particularly alert – the Pre Budget Report in November or December, and The Budget in March.
On both these occasions the Chancellor of the Exchequer announces tax rates, and new tax legislation, which might well affect you and your property business. In some cases, however, new tax legislation is announced at other times – it pays to keep an eye on the financial pages of the newspaper, or to subscribe to a magazine or journal that will alert you to important tax changes that may affect your business.
End and start of the tax year
The tax year ends on the 5th April each year and it is a good idea to review your tax situation before this date to make sure you are not missing any planning opportunities.
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