This article appeared in the Yorkshire Post on Saturday 8th July 2006.

How to Use the new Rules to Best Advantage

Duncan Meredith Senior Tax Consultant

The property market continues to boom and activity in this sector remains strong. Many individuals continue to invest in residential and, increasingly, commercial property. Developers remain busy.

Over the last few months, Taxing Times has covered a number of areas where special rules exist to provide some relief from tax. These include furnished holiday lettings, flats over shops, rent a room relief, principal private residence relief and VAT concessions for domestic property.

We have also looked at property refurbishment, features of property investment, including whether to use a company to hold the premises, and the impact of property ownership on pension funds.

Current issues faced by many individuals and businesses include enhancing the value of property investments in pension funds under the new restricted borrowing rules introduced in April 2006. A new approach to structuring property development can help to mitigate the effect of these restrictions. We have seen this new approach offer benefits to individuals, businesses and property developers, looking to use pension fund assets to greater effect than might otherwise be achievable.

The continuing enthusiasm for entering into property transactions means that tax is always a major concern. Many property sales lead to substantial capital gains tax liabilities and various techniques are employed to reduce these by maximising taper relief, spreading out the ownership of the property and staggering sales over different time periods. It is sometimes possible, on top of these, to mitigate the remaining gains with suitable planning.

Property has the feature that it increases rapidly in value, which is of course why it is so attractive. Sometimes the value explodes, such as when planning permission is granted. This makes it vital to seek advice at a time when values are low, before gains have accrued, when it can be expensive, in terms of a tax charge, to change the structure of the property ownership to be more tax-efficient.

It is always helpful to think of any property transaction in terms of its stages. Simply, these are purchase, ownership and sale. The purchase and sale are classed into the two main categories of trading and investment (although there is some ‘cross-over’). These are referred to below and each has its issues but the overriding concern is obtaining a deduction for expenditure, at least by matching it against the proceeds on sale.

The same applies to transactions within the period of ownership. Income that is taxable needs to be offset to the maximum extent by a deduction for expenses. All aspects of the property venture must be considered, not least funding costs and interest.

The nature of the tax charge on any property transaction depends on the fundamental principles of trading and investment. Broadly, trading can be carried out in property as with any other commodity, and the ‘manufacturing’ process (property development) can be present as well. Tax planning for property trading transactions is interesting and, in some ways, there are more options. However, the tax rates on profits can be high and there are many traps for the unwary,

If investing, the issue is capital gains and very different planning has to be considered. Sometimes it is possible to do something about a capital gain even after it has been realised but it is always better to seek advice at the earliest stage. Don’t fall into the trap of waiting for the gain to have happened before you decide to do anything about it.

The successful property investor, whether as an individual or through a company, will soon find that success has a price in terms of a growing burden of potential inheritance tax on their estate. Careful planning in this area is essential and it is advisable to look ahead to address the issues sooner rather than later.

Once the province of lawyers, stamp duty land tax (SDLT) is now a major consideration in all property situations. With rates up to 4% and little relief for situations where ownership is changed, even in quick succession, care must be exercised. The increased impact of SDLT and the proposed Planning Gain Supplement both indicate that the Chancellor is as keen to cash in on the continuing property boom as anyone.

Garbutt & Elliott are Chartered Accountants and Tax Advisers with offices in Leeds (0113 2739600) and York (01904 464100). Duncan Meredith, Tax Consultant can be contacted at the York office, or by email to dmeredith@garbutt-elliott.co.uk.