Influenced by a chronic undersupply, rising demand for property in the UK and the turbulence of the last two years owing to the pandemic, long-term forecasts for property investing are incredibly optimistic. We could see the UK home prices grow by 21.5% by 2025.
On the other hand, JLL, the real estate and investment management firm, predicts that the average rental price for a UK investment could rise by 2% in 2022, leading to an 8.5% increase over the next five years. Forecasts like this make people sit up if they want to invest in a property to buy to let.
But what is a better channel to maximise returns amidst low-interest rates and incredible demand? Should one trade in a property or invest in it for the long run? Let us consider the two options and where they stand from a tax perspective:
Property investors hold on to their property assets for an extended period as fixed assets. In this case, it is likely they also let their properties to raise revenue.
They may build their own property/ies. However, with rocketing sales prices, the property will not be marketed or sold immediately after the development work is complete.
Property investing is similar to the dividends from holding share investments or the interest received on bank deposits; the investment income is passive, and the property investor does not have to do anything to generate income.
The tax implications of the property investment status include:
- No NICs are due.
- Costs are not allowable once the property is no longer being let.
- Profits from the rental activity are subject to income tax – at rates as high as 45%.
- Losses from renting out one property may be offset against the income received from other properties.
- Any finance costs or repairs are not allowed for Capital Gains Tax (CGT) purposes unless the investment property is being let out.
- On the other hand, profits from the sale of investment properties are subject to CGT at no more than 28%. The percentage drops to 20% for non-residential properties.
A property trader purchases to make a quick short-term gain through a refurbishment and then flipping the property. The property may or may never be let out, and profit is made when the property is sold for a higher price.
While there are specific indicators of trading activity, it should reasonably be straightforward to spot a trading developer as the property will rightfully be marketed for sale – usually sometime before the development work has finished.
The tax implications of the property trading status include:
- There are no restrictions for dwelling-related loans.
- National Insurance contributions (NICs) will also be due.
- Any losses made on the project can be set against income from other sources.
- The interest costs for the project period will be allowed against income derived from there.
- Profits from the sale of a developed property will be treated and taxed as income to a maximum rate of 45%.
Property investment or trading: What is the better option?
For many, purchasing a property, glossing it up, and selling it for a profit is an attractive proposition. However, it is not as clear-cut. From a tax perspective, investing in a property and trading are crossed, and the consequences are not the same.
Suppose the goal is to sell the property for more than it costs to buy and refurbish it for tax purposes. In that case, it is essential to determine whether that surplus is a chargeable gain liable to CGT or a trading profit liable to income tax.
A gain in an investment property is taxed as a chargeable gain. Alternatively, if the property market fell and the property was sold at a loss, it would be an allowable loss. Any gains over the annual exempt amount would be charged at the residential property rates of CGT.
Let us study two examples to understand the clear distinction:
Alice purchases a run-down property as a long-term investment to refurbish and rent it out. Due to personal circumstances, she decides to sell the property shortly after the renovations are over, earning a gain of £50,000 – even though the original intention was to hold the property. Therefore, the gains are chargeable to CGT.
Melissa purchases a run-down property but sees it as an opportunity to make a quick profit. She gets the property renovated and sells it as soon as the work is done – making a profit of £50,000. She uses the profit to invest in another property, which she refurbishes and sells, this time making a profit of £80,000!
Unlike Alice, Melissa is trading. She intends to buy and sell properties to make a profit, which is charged to income tax as trading income.
Property investment or trading: A matter of distinction!
HMRC will consider factors such as how long the taxpayer owned the property, whether the sale and purchase is a one-off thing or a part of a series of transactions – whether it was bought for personal enjoyment or rented out.
The tests for whether one was investing in property or simply trading in it are the same for any other trade and are called “the badges of trade.” Every property transaction does not need all the badges to be regarded as an investment or trade.
However, some badges will carry greater weight than others. Therefore, the situation will always need to be considered carefully, keeping in mind the facts and the taxpayer’s intentions. If you are looking to invest in a property or are already trading in it and want some financial advice, book a free consultation with us today!