What sort of property business do you run? This is the first in a series of articles that we will be running in Landlord News explaining how to optimise the ownership structure of your property business for tax purposesMake Text Bigger
Building on the success of a property business involves much more than managing tenants in rental homes.
Many investors start to lose a grip of their property business once they have two or three successful property transactions under their belt and their portfolio starts to grow.
As the business expands, the business management cracks begin to show because many investors don’t think through keeping good financial records and controlling cash flow and expenses.
The common cry then is the administration involved in running a property business taking over an investor’s life rather than providing the cash to make living easier.
Structuring a property business
The first step in structuring any property business is making sensible decisions about exactly what kind of business it is from day one – that’s the day you put pen to paper to complete on taking on ownership of your first property.
Don’t forget that no one can unravel tax retrospectively, so whatever decisions you made on day one of taking on a property stay with you unless you take action to structure your business.
That sounds simple but if overlooked undermines any good work a property investor puts in to his or her business.
The reason is simple:
- Many property investors do not realise they run more than one property business at the same time
- The type of property business determines what financial records to keep, what accounts to produce and which sections of a tax return need completing.
Get that wrong and all that time and effort put in to logging income and expenses on spreadsheets and producing financial reports is wasted.
Understanding property business tax rules
First, clear up the terminology so everyone sings from the same rulebooks.
A property business is not the same as running a plumbing business, newsagent, or consulting firm.
According to HM Revenue and Customs (HMRC), they are trades or vocations that are governed by a set of rules that lays out how to claim business expenses, keep financial records, and calculate tax.
The rules for keeping financial records are similar for a property business, but owning rental property is not a trade but an investment, and calculating the tax to pay differs.
Property investing is a popular term that covers a multitude of business activities but has a specific meaning in tax law.
Investment is renting property to generate income
Property can be land, a home, or commercial premises. In tax law, the term can also cover letting out a permanently sited caravan or houseboat as a home.
Buy to let, student lets, shared housing (houses in multiple occupation or HMO) are property investments.
Hotels, camp sites, B&B’s and similar establishments come under different rules because the additional provision of services offered alongside payment for accommodation makes them a business instead of an investment.
Property investment businesses are split between two categories for tax purposes.
- A UK property business that covers any buy to let property located in England, Scotland, Wales or Northern Ireland. That’s it, nowhere else!
- An overseas property business covers rental property sited anywhere else.
Property investment can also include renting out furnished self-catering holiday lets – and this splits a property business again.
Until April 5, 2011, holiday letting businesses can be based in the UK or overseas with special tax dispensations for properties in certain European countries.
From April 6, 2011, a property investor can run a furnished holiday letting business in the UK or the European Economic Area (EEA). Any properties located outside these boundaries become overseas rental properties and slot in to any overseas property business.
Developing is buying property to sell at a profit
A developer deals or trades in property, much the same as a car salesman wheels and deals in cars. Developing property is a trade and covered by the same tax rules as any other trade or vocation.
A property developer buys property as business stock, adds value by refurbishment and sells on at a profit just as the car dealer buys a vehicle as stock, adds value by renovating and then looks to make a profit on the sale.
The geographical location of a property is not relevant – the property is either a development or it isn’t.
Why the difference between investing and developing is important
This is the crucial point for most property people where things start going wrong:
- An investor is not a trader and pays income tax on rental profits and capital gains tax on any increase in the value of an investment when the property is sold.
- A developer is a trader who pays income tax on the profits the development business makes when a property is sold.
This means you have to establish your intention for a property when you first take on ownership, whether you buy, inherit, or receive your share as a gift.
Your intention determines whether the property is an investment or a development – and that decision sets what tax you pay.
From that decision, you know what records to keep, the accounts to produce and how to fill in your tax return.
Getting the purchase intention wrong can open up a whole world of pain with the taxman.
HM Revenue and Customs will always try to prove a property is a development rather than an investment if any doubt surrounds the purchase intention.
If they can show a property is a development, generally that means the owners pay more tax because the tax rates are higher (40% against 28% at the top rate) and less reliefs and allowances apply.
The odds are unless a property investor has kept good financial records, they won’t have the evidence to rebut the taxman’s argument, especially if the property has been owned for several years and paperwork is lost.
It is in every property investor and developer’s interest to keep detailed, written financial records in a logbook for every property.
Many property people buy a property and then make a decision whether to hold and let or sell and base their tax returns on what they did with the property rather than the initial intention on purchase.
This can lead to property investors paying out too much tax simply because they do not know the rules and how to play them to their advantage.
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