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Planning Your Tax Strategy

Planning Your Tax Strategy From Day 1

Being aware of tax issues and implications before you even start investing in properties is a must. Too many people have jumped into the property market without thinking through their strategy and tax matters, only to find themselves incurring unnecessary expenses to rectify matters later on.

To Pay or Not to Pay Mr Taxman?

Like everything in life, we have two options. We either ‘do it’ or we ‘don’t do it’. Whichever choice you make may lead to you regretting it.

Similarly, with Mr Taxman we also have two options: Either we ‘pay him’ or we ‘don’t pay him’.

However, deciding the latter, intentionally or indeed unintentionally, means that you will most definitely be regretting it when he catches up with you. I re-iterate the point when, as you will always hear of people who manage to avoid Mr Taxman without any problems. In today’s society, Mr Taxman has more power and resources, and like he says himself, ‘the loop is closing’.

As Benjamin Franklin (an observer in 1789) said, there are two things in life that are inescapable – Death and Taxes. Well I would disagree, as I believe that there are three things that are inescapable – Death, Taxes and Ill Health.

Trying to just avoid paying taxes can seriously damage your health! Imagine running from somebody who you know that, if he catches you, will probably take what you genuinely owe him and much, much more. Imagine being landed with huge fines and even possibly a jail sentence!

Now consider this. Paying taxes not only keeps Mr Taxman off your back, but it keeps you a lot healthier and you can probably live a lot longer! However, more important than all these points is that by paying tax you actually save money!

Therefore, if we want to make more money, be happy and live longer, then it really does make sense to be aware of taxes and pay Mr Taxman.

Remember tax is about two things:

• Formulating your property tax minimising strategy (NOT evasion).
• Helping you to understand the taxes due so that you can plan ahead to pay them AND sleep at night.

Property Investor or Property Dealer?

Everybody who invests in properties will either be classed as a ‘property investor’, a ‘property dealer’ or both. It is important to classify yourself before you start investing so that you have an appreciation of what your tax liabilities will be.

Property Investor

A property investor will invest in a property long-term.

Generally speaking, you are likely to be investing in property if you acquire a property to generate rental income.

Adopting this strategy, you are likely to hold on to your investment for a number of years before you dispose of it.

The longer you hold on to your property, the more likely it is to be classed as an investment. It is safe to say that if you hold your property for at least 5 years, you are unlikely to be open to attack from the Inland Revenue.

Property Dealer

A property dealer will invest in a property short-term.

You are likely to be a property dealer (also known as a trader) if you are purchasing a property with the intention of selling it to produce a dealing profit.

Adopting this approach is likely to mean that you will not be renting your property to generate income, but instead will be looking to sell it quickly so that you can realise your trading profit.

A property dealer is only subject to Income Tax. You will not be liable to pay CGT.

How to know if you are investing or dealing?

The Inland Revenue will apply some basic rules to determine if you are acting as a dealer or an investor. The fundamental and most significant test is as follows:

Motive for acquiring the property

If you acquired the property to generate income, then it is investing. However, if you acquired the property to generate a profit by quickly selling it on, then it is classed as dealing.

If the motive for acquiring the property is clear, then no further tests need to be applied. However, if it is not clear then you may need to provide proof for the following tests:

Length of ownership

If you have property that you own and have let out for only a short period of time i.e. one or two years, then the Inland Revenue could class you as a dealer. However, if you have held your property and let it out for five years or more, then the Inland Revenue is likely to be satisfied that you are investing.

Rental income

If you are an investor and are letting your property, then you will need to prove that rental income has indeed been received. The best way to do this is through bank statements and/or receipts.

Failure to provide proof of rental income could lead to you being classed as a dealer, even though you believe you are investing!

Method of finance

If you are a property investor then your loan for the property is likely to be financed over a long term i.e. 25 years. If you are dealing, then your finance is likely to be over a much shorter period i.e. one or two years.

Key Tip

Remember - ‘Knowledge is Power’ - Make sure that you know whether you are investing or dealing. If you know, then Mr Taxman is more likely to believe you!

Knowing Your Property Investment Tax Strategy

Having decided whether you want to be classed as an ‘Investor’ or a ‘Dealer’, or indeed both, you will now start to think about your actual strategy. Your strategy will probably consist of one or more of the seven listed in the table below. The table shows the taxes that you will be liable to pay for each strategy and gives a general classification to inform you whether you are investing or dealing.

Property Investment Strategies

KEY
Investing / Dealing
Income Tax
CGT

1 Buy-to-let Investing Yes Yes
2 Buy-Develop-Let Investing Yes Yes
3 Buy-Develop-Sell Dealing Yes No
4 Buy-Sell Dealing Yes No
5 Buy-Live-Develop-Sell Investing No No
6 Buy-Live-Sell InvestingNo No
7 Let-to-Buy Investing Yes Yes
8 Buy-Let-Live Investing Yes Yes
9 Rent a Room Investing Yes No
10 Holiday Lettings Investing Yes Yes

Let’s have a look at each one of these strategies in more detail and understand our real tax implications.

Buy-to-Let

Following this investment strategy you will be buying either newly built properties, or you will be looking for properties that are in an excellent condition and that do not require any improvements. Once a property has been purchased, your intention will be to let it out as soon as possible. This strategy is growing in popularity, especially with the current buoyant buy-to-let market. The people who tend to follow this strategy are those who currently have their own home and want a second or third property purely for investment purposes, to supplement their pension when they retire!

Such a strategy will incur both Income Tax on rental income received and CGT when you decide to sell the property.

Example: Buy to Let

Mr Jo Jaffa buys an investment property for £50,000. Without carrying out any development work he rents out his property for £450 pcm. His expenses for the property are £150 pcm. Therefore, he is earning an additional £300 pcm as income, upon which he is liable to pay Income Tax. If Mr Jo Jaffa then sells his property for £60,000, he will also be liable to pay CGT on £10,000.

Buy-Develop-Let

This is also an investment strategy. This strategy is likely to be followed by the budding enthusiast who not only wants to develop properties but wants to let them out as well.

Those who venture down this path, and decide to purchase a property so that it can be developed before it is let, will also be liable to pay both Income Tax and CGT.

Example: Buy, Develop, Let

Mr Jo Jaffa buys an investment property for £25,000.

He spends £15,000 on developing the property before he rents it out for £450 pcm. His expenses for the property are £150 pcm.

Therefore, he is earning an additional £300 pcm as income for which he is liable to pay Income Tax.

If Mr Jo Jaffa then sells his property for £60,000, he will be liable to pay CGT on £20,000 only. This is because the initial purchase cost of the property and the development costs are deducted when calculating the gain.

Buy-Develop-Sell

This strategy is likely to be followed if you have no interest in getting involved in the letting markets. If you have mastered the art of buying run down properties or even building new properties, then you will only be liable to pay Income Tax. CGT will not apply to you.

You will not be required to pay CGT as you are classed as a ‘dealer’, where buying and developing properties is regarded as being your trade/profession. This rule is similar to that of a regular stock market investor. If you are trading shares on a regular basis i.e. for regular income, then this is classed as your profession and you are taxed on any income you make. Again, you do not have to pay CGT.

Example: Buy, Develop, Sell

Mr Jo Jaffa buys a run down property for £10,000. He spends £25,000 on developing the property before he decides to sell it for £60,000. Therefore, the total cost of the property was £35,000. Mr Jo Jaffa will be liable to pay tax on the £25,000 profit that he makes.

More pages

Page 1: Planning Your Tax Strategy From Day 1
Page 2: Buy-Sell