Where clients have interests in property, whether they buy, hold, receive rental income or benefit from capital growth when selling a property, it will be important to establish from the outset whether they are investing or trading in property as the tax treatment can vary significantly.
The difference between investing and trading in property
If your client has been investing in property, they could be subject to Income Tax (up to 45%) on any rental income and Capital Gains Tax (up to 28%) on any disposal of assets.
If your client has been trading in property in a self-employed capacity, because buying and selling is their business, it is possible that they pay Income Tax and National Insurance on ‘profits’ each year. ‘Profits’ can include rental income and proceeds from any sale, although Landlords don’t pay National Insurance on letting income. Those trading in Property also have to contend with the construction industry scheme (CIS) as an added complexity.
HMRC are actively looking at investment and trading in property
We have seen HMRC be particularly active in this area recently. HMRC has tried to argue that clients are trading in property and that Income Tax (at higher rates) and National Insurance should be payable on the proceeds from property disposals, which have originally been treated as investment income.
It’s not all bad news! Further deductions may be available if it is determined to be a property trading business. A person may also be eligible to claim Business Asset Disposal Relief (BADR), allowing gains to be taxed at a reduced rate of 10% on a part or complete disposal of their business. Rollover relief may also be available where the funds are reinvested into a qualifying asset.
Documentation and intention
The tax consequences often come down to your intention when you purchased the property. Clear documentation of intention at the time of buying and selling the properties has proved key in establishing the circumstances at the time.
Badges of trade
The nine ‘badges of trade’ developed by the courts apply equally to the question of whether a person is trading in property as to any other trade. They can be useful in determining whether the activity is trading or investing in property.
It is not necessary for all ‘badges’ to be present and some ‘badges’ carry greater weight than others. Some of the key ‘badges’ in determining whether someone is trading in property are:
- The presence of a profit seeking motive.
- The number of transactions
- The nature of the asset
- The method of acquisition, including whether and if so on what terms finance was used.
Taking advice and clearly documenting the intention for a property from the outset can be critical in the event of an HMRC challenge.