Buying a Property: A Tax Planning Checklist
You could be forgiven for thinking that buying a property was sufficient hassle anyway, without having to bother your head about tax matters at the same time. Unfortunately, though, making the wrong decision in any of the areas mentioned below could have a serious effect on the amount of tax you pay in the future. So we hope that what follows is a handy checklist for readers to cut out ‘n keep for future (or present) use when in the throws of negotiating a property purchase.
What any kind of generic article like this can’t be, of course, is a complete “pack” enabling you to decide exactly how to do things: inevitably the aim has to be less ambitious than that, in listing out the questions you should be asking yourself before buying a property, and explaining why these questions are so important. In some cases the answers to the different checklist items will, indeed, point in different directions. The art is then deciding which of the various tax reliefs etc are more important to you.
1. Are you financing the purchase in a tax efficient way?
Typically, a property purchase is financed partly by borrowing from a bank or building society, and partly out of one’s own resources. The days of 100% mortgages are not quite past (indeed there signs that they may be returning), but typically a reasonably substantial deposit is going to be needed.
A conundrum that often arises is where the money you have, which you want to devote to putting down the deposit, is in a limited company over which you have control. The “straightforward”, and highly tax inefficient, way of doing things is to take the money out of the money as a dividend and buy the property in your own personal name.
But consider the alternatives. A reasonably straightforward alternative, if the bank will lend to the company, is for the company itself to acquire the property. That way you don’t lose the up to 38% or so income tax that HMRC will grab off you because of the dividend. Buying in a company isn’t always ideal – there are lots of pros and cons, which we would be digressing too much to list out in full here, but there is also a “third way” to take into account as an option.
This is buying the property in an LLP in which the company is a member. The company introduces the funds it has and which are needed as equity capital into the LLP, and you, as an individual, are also a partner in that LLP alongside the company. So you can get many of the advantages of individual ownership, including arguably lower CGT rates, the ability to take the rents without paying “dividend tax”, and so on, whilst at the same time using the company’s money to fund the purchase. An example of the “best of both worlds”.
2. Is the “Buy to Let” Loan Interest Restriction a problem?
This has been very much in the news recently, of course, and a lot of (in our view completely justifiable) indignation has been caused by these new rules, which phase in over four years from April 2017. In short, interest paid on loans to buy such properties will no longer be available for higher rate income tax relief. In some cases people will end up paying more tax than they are actually receiving in net rents.
Why is this a planning point? Because, as is reasonably well recognised in the buy to let community, limited companies are not subject to this tax relief restriction. So, if you are a potential sufferer from these new rules, consider buying either in a company or in an LLP with a company member, providing the finance via the limited company.
3. Might you be caught by the new 3% Stamp Duty Land Tax surcharge?
Another headline grabbing move in Mr Osborne’s apparent campaign to annoy as many different sectors of society as possible, was the imposition of a 3% SDLT surcharge for purchases of residential property on or after 1 April 2016. Contrary to some mythology which still seems to be floating about, this applies to all potential purchasers, and limited companies aren’t exempt. Indeed, limited companies are less favourably treated than individuals, because there are no circumstances in which they can pay anything other than the “enhanced” SDLT rate.
So, if the circumstances are right, think about whether there is any way that you can enjoy the old SDLT rates, without the 3% surcharge. There are two ways to do this:
- Be an individual who owns no other residential property; or
- Be an individual who owns other residential property, but who are buying this property as your main residence.
There are no doubt interesting planning possibilities in respect of the first of these ways of getting relief. Interestingly, if you don’t own any other residential properties, you pay the lower rate of SDLT even if what you are buying is a buy to let property. So we foresee the spreading of ownership amongst family members, perhaps, here. But bear in mind that you don’t get relief for joint purchases where any of the joint purchasers have another property and where the property being bought isn’t the main residence of all the purchasers.
4. Is there any Non SDLTable element in the purchase?
Although this planning idea isn’t new, its become much more important with the massive hike in SDLT rates in recent years (most of us still remember the time when stamp duty was only 1% flat).
In its most straightforward form, you could separately value things like the carpets and curtains in a residential property, and exclude that from the purchase cost. So anything which isn’t a fixture (a fixture being legally part of the building and therefore subject to SDLT) should be valued at its full value and taken out of the SDLT calculation. Moving on from the carpets and curtains scenario, there are potentially big savings to be made if the property you are buying is “trade related”.
This is a big source of wrangling with HMRC at the moment, but fortunately HMRC are quite demonstrably wrong: and they know it. Let’s give a bit of explanation of what we are talking about here.
A trade related property is one where a business is being carried on in the property, and where the identity of the property itself is central to the success of that business. Examples of this are pubs, restaurants, hotels, and care homes. Because the trade and the property are so closely linked in examples like these, the reality of the situation is that, when you buy a trade related property, you are buying both the structure of the building itself and the goodwill of the business. And this is where the dispute with HMRC comes in.
The Revenue’s view, although it seems to have changed somewhat, is basically that you can have little or no goodwill where you are buying a trade related property, because of the way they say you should value the property, and particularly how you should apportion the purchase price between bricks and mortar on the one hand and goodwill on the other. Unfortunately for HMRC, no chartered surveyors (outside the Revenue itself), and no accountants agree with them. Oddly, the cases on this point which are currently progressing towards the first tier tax tribunal are being subject to massive delaying tactics by HMRC: what can they be afraid of?
So, in the meantime, you should certainly stick up for your rights, and follow what all the real experts say, by making a fair apportionment of what the property would be worth without the trade, and what it is worth with the trade, and allocating the difference to goodwill – which is not subject to SDLT.
This one is relevant if the property you are buying is either not a “dwelling house”, or is a dwelling house which you are going to use as a furnished holiday let. In case anyone has missed our banging on about this point in previous articles, and for new readers, we’d briefly explain, here, that when you buy a property you are buying a mixture of structure (for which there is no tax relief against any income you receive from the property) and fixtures (for which there is tax relief). So when you’re buying a property like this, you need to be careful that you are picking up the full tax relievable value. Not only that, though, but there is now red tape to be satisfied before the purchase completes.
In the past HMRC have been incensed by taxpayers claiming relief for expenditure that they are due relief on: as a result of claims instigated by wicked capital allowance consultants. So their response, predictably enough, has been to make it much more difficult for you to claim your due. We won’t go into the details here because if your solicitor is switched on he will know about them, or have access to advice about them, but suffice it to say that you need to get the fixtures element, and the vendor’s treatment of fixtures in the past, agreed before you sign that contract.
6. Does the property need work done on it?
This question is relevant if you are buying a property from which you expect to derive an income: either by letting it to a tenant or by occupying it yourself for the purposes of some business.
As far as tax relief is concerned, there is a right way and a wrong way of doing the work once you have got possession. Commercial and other considerations may trump the tax ones, of course, but basically the wrong way is to do a massive one off refurbishment before you start occupying the property; and the right way is to do the work that is needed gradually over a period.
The reason why the tax system favours the latter way of doing things is because major expenditure, particularly on purchase of a property, tends to be disallowed by HMRC as “capital” – so that you only get relief for such expenditure when eventually you sell the property, and you claim this as improvement expenditure against your capital gains. Even this relief is only available if the expenditure is still reflected in the state of the property when you come to sell it.
By contrast, gradual work over a period is likely to be allowed as “repairs and maintenance”.
7. Can you “spread” the future capital gain?
Most people who buy properties, other than their main home, buy them with a view to enjoying future capital growth: which, at least to judge from past performance, would seem to be a certainty. Capital gains tax will ultimately be payable, in all probability, on that future growth in value when you come to sell the property. CGT is charged at a rate of 28% for residential properties and 20% for non residential. But each individual owner has available an annual exemption from CGT, which is currently worth about £11,000.
So, to state what is almost the obvious, if a property was bought in the name of say five members of one family (including children who are under eighteen) you will have over £55,000 exemptions to offset, potentially, against that future gain, rather than only £11,000 or so if you buy it in an individual name.
You may say that spreading the ownership of a property like this is easier said than done, because a bank is unlikely to be interested in lending to joint owners who are not spouses and are either very young or have no income of their own for other reasons. Perhaps an answer to this sort of situation might be buying the property in a family LLP, which takes out a loan from the bank on a commercial basis. Within an LLP you can write the rules such that any future gains are shared out amongst the family or other individuals so as to maximise the annual exemptions. This is obviously rather more ambitious planning than simply buying property in joint names: nevertheless it could pay dividends in the future if the numbers justify it.
8. Capital losses, anyone?
Sometimes you will find that one of the proposed purchasers, or someone associated with them, has made some kind of capital loss in the past. For example, they may have invested in an unsuccessful business or other investment. So the question arises as to whether one should arrange things, on purchase of the property, to ensure that any future gain on selling that property accrues to the person who has the capital losses. Capital losses can’t be passed from person to person, and although you could move the ownership of the property itself to the person with capital losses brought forward at some future date, this disposal is itself likely to give rise to capital gains tax at that time on the transferor individuals. So it’s obviously best to get things the ownership from the outset.
9. Does anyone have rental losses brought forward?
A similar consideration applies if one or more of the proposed owners of the property, or someone closely associated with them, has losses of an income nature brought forward. If, for example, you’ve consistently paid more interest, and laid out more in repairs etc, than you’ve been receiving in as rents, these losses are brought forward automatically and offset against any rental profits you make.
Or not quite any. HMRC will claim that the profits have to arise in the same “business” as the previous losses did. Whilst not everyone agrees with them in applying the rules with the same rigour, if it is possible to structure the ownership in exactly the same names for the new property as the losses were incurred for the old property or properties, this will make challenge by HMRC for the use of the losses impossible.
10. Can you structure the purchase to get Rollover Relief?
Rollover relief is a relief against capital gains tax (CGT). If an individual or a company has made a gain from selling a property, or indeed another type of asset within certain specified classes, the tax on that gain can be rolled over if there is the purchase of a property, which is also used for the purposes of a trade, at any time in the period one year before to three years after the sale of the old asset.
So again it’s a case of making sure that the person or entity that makes the acquisition is the same as the person or entity that made the gain on the old asset.
It may even be that there is an option as to whether to use the property, at least initially, as a trading property and hence make rollover relief available where it might not have been. Interestingly, if you sell an asset you use for a trade, and buy a property which you also use for a trade immediately on acquisition, the gain that is rolled over into the new property doesn’t get clawed back and taxed if you then subsequently cease to use the new property for trading purposes.
11. Can you structure the purchase to maximise Inheritance Tax Business Property Relief?
There are two different scenarios where your choice of ownership structure for the new property could result in a lot more of your estate enjoying 50% or 100% relief against inheritance tax under the Business Property Relief provisions.
In scenario one, the property you’re buying might be a “pure” investment, which you are going to let out to an unconnected tenant for rent. If, though, you are also running a trading business, there may be a way to domicile both the trading business and the investment property together so that overall the entire value still qualifies for relief. Relief is available for a business or an interest in a business; or for the shares in a company carrying on a business, except where the business concerned is wholly or mainly one of making or holding investments.
So the implication of this is that, if you have at least 50% in the nature of trading activities in your business, you will get relief for the whole value. Mixing together investment properties and trading assets in this way can therefore get you relief where relief wouldn’t have been available if, say, you’d bought the investment property outside your trading business entity. (Obviously there are a lot more considerations to take into account, in deciding whether to buy a property within the business entity, and what business entity to have in the first place, that we have no space to discuss here.)
Scenario two is where the property you are buying is itself to be used for the purposes of a trade. If you are increasing the scale of your business assets in this way, could you consider doing the converse to the above, and moving other properties which perhaps you own and which are investment properties, into the same ownership as the new trading property?
12. Could you be moving the value out of your inheritance taxable estate?
Again, this is a question of whose name you buy the property in. One way of planning against your own inheritance tax exposure on death would be to execute a trust over the property, under which future increases in value in a property effectively go to the trust rather than going into your estate. For example, you could loan money to the trust, which becomes the legal owner of the property, and which, apart from repaying your loan, excludes you from benefiting. So when the value of the property goes up in the future this doesn’t swell your inheritance taxable estate.
13. Are you buying the property for someone else to live in?
If so, why not consider a different sort of trust arrangement?
The most common example of this scenario in practice is where parents buy, or help to buy, properties for their children: either to live in at university or later on in life. Sometimes the parents are reluctant to wave goodbye to the value completely, and so their temptation is to put the property into joint ownership, with themselves having an interest in the property corresponding to the amount of financial help they’ve given.
But the problem here is that the parents’ share doesn’t qualify for main residence exemption, even though the property is, perhaps, the main residence of the children. So capital gains tax would be payable on the part of the proceeds, on ultimate sale, that relate to the parents’ share.
You can get round this by buying the property in a “Section 225 Trust”. This trust has both the parents and the children (in our scenario) as beneficiaries, and the parents put money down to help fund the property. Do watch out for inheritance tax charges here, incidentally, because inheritance tax is due where money is put on trust which exceeds the nil band for each settlor (currently £325,000).
Leaving that inheritance tax issue aside, though, the benefit is that the whole gain on the property should now qualify for main residence exemption, on the basis that the children, who are beneficiaries of the trust, are living in the property as their main residence. And this is not in any way inconsistent with the parents still keeping a stake in the ultimate proceeds themselves, because they are beneficiaries of the trust too. It is just that, as beneficiaries, they aren’t achieving any effective inheritance tax planning by setting up the trust in this way.
14. Should you be making a main residence election?
Still on the topic of main residence exemption from capital gains tax, this question is relevant if the property in question is being bought as a second (or third etc) home.
The basic rule is that you don’t pay tax on selling your own home, but that this relief only applies to one home, not to several. Because it can be a difficult question of fact deciding which of two or more residencies is the main home, the legislation has very sensibly given the taxpayer the right to nominate which one they want to enjoy the exemption. But the action point, which everyone should consider in this situation at or around the time of purchase, is that you only have a two year window in which to make this election.
So consider carefully both which property you are most likely to sell, and which property is likely to give rise to the biggest gain. Then make sure you put in the election in time, and, for a married couple, make sure that both husband and wife sign the election.
Buying a new property, interestingly, doesn’t just give you the right to nominate that property as your main residence: it also gives you the right to nominate any of your other properties as your main residence from that date, even if you’ve owned those other properties for more than two years. So, in situations where you may feel you’ve missed the boat, because you’ve owned the properties beyond the deadline for making the election, you can revive the deadline, and start a new two year clock ticking, by buying a different residence, even where you don’t propose to nominate that newest of the residences itself as your main one.
Still on the subject of main residence relief from CGT, if you are a couple who aren’t married, you can maximise your main residence relief by buying two residences in your respective names. That is, rather than each of you owning the two residences jointly, partner A could own 100% of property A, and partner B could own 100% of property B. By making judicious use of the main residence election, you’ve doubled the available tax relief.
15. Are any of the proposed owners in financial trouble, or could they be in the future?
We’ll finish off here with a point which isn’t strictly about tax planning at all: but it is relevant because making a purchase in the name of a given individual might be excellent planning from the tax point of view, but appallingly bad planning from the much more important point of view of asset protection.
This point of view is very simply expressed: if you put the property, or a share in it, in the name of any individual or company which could run into financial difficulties in the future, or is even in those difficulties already, you are endangering the whole asset. Often the way round this is to hold the property in some kind of trust arrangement for the financially vulnerable individual. The property is therefore still being held for their benefit, but, hopefully, should be outside the reach of the individual’s creditors.
Hopefully the above list of questions isn’t so formidable as to put you off the idea of acquiring a property at all! Clearly not all of the checklist items are relevant to all purchases, or even most of them. It’s equally clear that there will be other important tax considerations, in individual cases, which we haven’t had space to list out here.
But we do think that most of the important points have been covered and, if nothing else, it is good to ask the questions so as to stimulate thought on the areas where potentially huge amounts of tax could hang on doing things one way rather than another.