Starting Out As A Developer
What Property Developer Tax Should I Be Aware of
Are you finally starting to realise your property development dream s? W hat an exciting and daunting experience it is completing the purchase of the development land or properties that need a refurb. You are ready for the challenge, but have you thought of the tax traps that aren’t always apparent w hen you set out on this journey as a developer?
Being a property trader versus an investor m ay seem the sam e in essence, but w hen it com es to tax there is a fundamental distinction that you need to consider early in your career or at the very least ahead of tim e in your development plans.
Firstly, lets define the two. Property trading is when the intention is to sell the development lot for profit (trading stock). Property investment is w hen the property is developed for long-term commercial gains, such as houses or apartments to let (investment assets). Changing your m ind after the development is complete can have distinctly unfavorable consequences.
What Are Tax Implications of A Trading Property Becoming An Investment Property
This is the most common tax trap that you need to be aware of.
Let’s say you have purchased a plot of land with a view to build six houses on it and sell them at a profit. The development has been successfully completed, and four of the properties have sold easily. Two of the properties are slow on the uptake so you decide to change the policy to keep the remaining two properties indefinitely and find tenants for them .
Example Property Tax Charges
Leaving aside the potentially disastrous VAT consequences of this (which can also be remedied easily if foreseen at the start of the project) we have a some what bizarre case of a ‘dry’ tax charge.
Each of the houses cost you (the developer) £ 200,000 to build, and each has a (theoretical) sales value of
- £350,000. W hen the decision is made to move the property over from trading stock to fixed asset investment property, the tax rule (which follow s a fairly old precedent, Sharkey v. Wernher H L 1955, 36 TC 275) will treat the developer as if the houses were sold to himself for their market value.
Therefore, you (the developer) are liable for a tax charge on the profitable
- margins that is assumed, in this example, 28% of £ 300,000. With no actual profits to pay the tax with.
This is a highly undesirable result, as
well as being a very perverse tax law ; so how if it all, can it be avoided?
What Are The Tax implications Of A Investment Property Becoming A Trading Property
Unlike the converse situation, there is no necessity for tax charge to arise
w here a property which w as held as an investment becomes trading stock.
- Whilst this ‘appropriation to trading stock’ (as it’s called in the Taxation of Chargeable Gains Act CG T of 1992, at s161) gives rise to deem ed disposal of the property for CG T purposes, it’s possible to elect to ‘hold over’ the profit and effectively introduce the property at original cost into the trading account.
The effect of putting property into trading stock, is that future profit on sale will be taxed as an income.
However, if the property is owned individually it is sometimes possible to bring about the result that a limited company. (with its much low er tax rate on income) received a share of the ultimate profits. One way of doing this for example, is for a company to be formed as the developer and for that company to realise a reasonable profit as part of the process.
The properties concerned are held within a private limited company, that has a change of status from ‘investment to trading’, meaning that the company may acquire trading status for CG T purposes.
Potentially making the company shares eligible for Entrepreneurs’ relief on a sale. Arguably even more important, a property or property portfolio which was previously held as an investment, turned over to an active property development trade should in principle qualify for business property relief from inheritance tax.
This opens the possibility of this situation being deliberately engineered in order to qualify a property portfolio for IHT relief. In principle, a long-held portfolio that is being disposed of due to the owner’s demise, an active decision to redevelop the portfolio con convert it into 100% relievable value.
In theory this is a tangible result, in practice, however, will require convincing the HMRC in an inquiry that what happened was not merely ‘window dressing’ to save a potentially huge charge of IHT.
What Is Proof Of Intention & How Does it Effect Me
HMRC LOOKS AT SEVERAL FACTORS TO DETERMINE INTENTION ,SUCH AS:
Accounting treatment – whether the property is accounted for as an investment or as trading stock What documentation, such as board minutes, says about intention at the time of acquisition and sale
- Whether the company history is one of trading or investment Length of ownership – less than three years suggests trading, but other factors are considered.
- Whether the sale was actively marketed
It is essential to keep good documentation of the above, as this is the clearest way of showing intent. With all of the implications in mind, here are our practical tips to ensure you get the most out of your development without getting caught in the traps.
What Property Tax Tips Can I Take Advantage Of
1. If you are developing a property with the potential of retaining some of it as a long-term investment, decide on what elements will be retained and take active steps to show evidence of your categorisation of that property as an investment.
2. If you redevelop an existing fixed asset with the goal to trade. This decision is a disposal for capital gains tax purposes, so if you provide an election to the HMRC, the tax consequences can be deferred .
3. In principle, a property portfolio which is fully chargeable to IHT could become a fully relievable portfolio if a genuine change of intention, fully evidenced, takes place.
Helpful Property Tax Definitions
Trading assets are a collection of securities held by a firm for the purpose of reselling for a profit. Trading assets are recorded as a separate account from the investment portfolio.
A fixed asset is a long-term tangible piece of property that a firm owns and uses in its operations to generate income. Fixed assets are not expected to be consumed or converted into cash within a year.
Inheritance Tax (IHT) is a tax on the estate (the property, money and possessions) of someone w ho’s died.
Capital Gains Tax (C G T) is a tax on the profit when you sell (or ‘dispose of’) something (an ‘asset’) that’s increased in value. It’s the gain you make that’s taxed, not the amount of money you receive.
Business Property Relief (BPR ) provides relief from transfer of relevant business assets at a rate of 50% Inheritance Tax (IHT) on the or 100% .