Residential property can be a lucrative business, but profits or gains will be subject to tax. In this post we discuss some of the property tax planning options, including using limited companies or LLPs, trading vs investment property, capital gains tax and entrepreneurs relief. Please download the full report on residential property tax planning for full details.
Trading stock vs Investment property tax planning
Residential property can be purchased for different motives and this will impact upon the property tax planning:
-
to be resold in the short term at a profit (trading stock)
-
for capital appreciation whilst generating rental income (investment property)
When trading stock is sold, it will generate trading profits which are taxable as business income. A trading business will also be eligible for additional tax reliefs such as Entrepreneur’s Relief and Substantial Shareholding Exemption to minimise tax.
An investment property, however, will generate capital gains or losses which are taxed differently, and many of the reliefs available to trading businesses are not available to investment businesses.
For properties held individually, higher or additional rate taxpayers will pay a much lower rate of 28% on capital gains from investment properties compared to 40% or 45% on profits from trading stock.
Limited company vs Individual property ownership
The tax liability will depend on whether owners are basic, higher or additional rate taxpayers. The example in the table below shows the tax payable on a gain/profit of £80,500 for a higher rate taxpayer:
|
Total tax paid using: |
Investment property (£) |
Trading stock (£) |
|
Ltd co. & all profits retained |
14,600 |
16,100 |
|
Ltd co. & all profits distributed |
31,075 |
32,200 |
|
Individual purchaser |
19,488 |
29,845 |
This clearly shows that for both investment properties and trading stock, a limited company would save tax if profits are kept within the business or are re-invested. This is because a company only pays tax at 20%.
However, if the company were to pay out the profits as dividends, there would be another level of tax. So if the intention is to extract significant profits on a regular basis, it may better to hold the properties individually. This is especially the case for investment properties as individuals can also benefit from capital gains tax allowances and CGT tax rates are lower than income tax for higher/additional rate taxpayers.
If multiple properties are purchased, multiple limited companies could also be used to contain risk if any 1 property runs into difficulties with mortgage repayments. Although lenders may demand cross or personal guarantees.
A director could also give a startup loan to the company to initially purchase property and this could be repaid tax free.
At the end of the company’s life, it could be closed down and the shareholder would pay capital gains tax on the return of capital. This may save tax compared to taking dividends out on annual basis. A company with trading stock could also claim entrepreneurs relief and so pay tax at only 10%.
The main disadvantage of using a limited company is that there is a double level of taxation, as more tax will need to be paid when the shareholders extract profits,
A limited liability partnership (LLP) may offer the best of both worlds,. This is because they are transparent for tax purposes and can be structured with 1 individual partner and 1 corporate partner. This allows capital and income to be allocated to partners in an efficient manner for property tax planning.
The following table highlights some of the key differences in property tax planninh:
|
Trading stock (business income) |
Investment property (capital gains) |
|
|
Corporation tax rate |
20%* (*if profits > £1.5m rate is 23% in 2013 & 21% in 2014 & 20% from 2015) |
20%* but can also deduct indexation allowance for inflation |
|
Individual tax rate |
Income tax rate (20/40/45%) plus Class 4 NIC (9/2%) depending on total level of income. |
Capital gains tax at 18% for basic rate or 28% for higher rate taxpayers. (also higher personal allowance for CGT) |
|
Entrepreneur’s relief |
Eligible: an individual could pay CGT at 10% on first £10m of lifetime gains, if dispose or close down a trading business |
Ineligible |
|
Substantial shareholding exemption
|
Eligible: a company can get tax free gains from selling trading companies if conditions are met. |
Ineligible |
|
Expenses (repairs vs capital)
|
Expenditure on the property will be added to stock, and so will normally get the tax deduction on sale. |
Immediate tax deduction for repairs which do not improve the property. Capital expenses will get relief from CGT on sale. |
Please download the full report on residential property tax planning for full details, including the following areas:
Loan interest
Substantial shareholding exemption
Principal private residence exemption
Investment property expenses: revenue vs capital
Valuation of trading stock
Further considerations
