Franklin D Roosevelt once said “Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the World”.
With volatile financial markets many of us see investment in property as safer and as an alternative method to the standard pension, upon retirement. The property may be “buy to let” or it could be a holiday home or even a property for children to occupy during their university days. It is estimated that there are approximately 246,000 second homes in the UK and if you own a second home or are planning to buy one then it is important that you are aware fully of the tax implications of so doing and the structure of how the property is owned.
Many owners do not get the right advice about simple steps which could help mitigate the potential tax liability and simply concentrate on the conveyancing aspects and not think of the bigger picture. To help minimise potential tax liabilities there are a number of ideas which can help:
1. Income Tax and claiming expenses
If you rent out your second home you will become liable for tax on the income you generate from letting it out. It is important that you notify the Revenue in your tax return of the rental income you receive. It is also important to keep careful records of all expenses relating to the letting out of your second home as those which are deemed “allowable” expenses can be used to offset against the income tax bill. Make sure the rent goes to the lower rate tax payer in the marriage.
In addition the professional estate agents and solicitors’ fees on the purchase of your second home together with the costs of any money spent on improvements to the property can be deducted when calculating the capital gains tax on a sale. It is important therefore that you keep receipts for all these items and speak to your solicitor about how these apply on the calculation of your tax liability.
2. Overseas local taxes
If you are planning to buy a second property abroad (as indeed over 400,000 Britons currently have) you may well fall into the local tax regime. Double tax treaties exist between the UK and certain overseas countries involving agreed limits of taxation to be divided accordingly. The rules change from country to country and therefore it is important to seek advice on the local tax situation before purchasing the second home. If overseas tax is payable then that tax payment is usually reduced if there are any outstanding UK tax liabilities in excess of that payment.
3. Own the property jointly
Second home owners will be liable to Capital Gains Tax if they sell their second property for a higher price than they paid for it. However, you can use your annual CGT allowance of currently, £10,600 to offset against any such gain but the end result is that you could be paying up to 28% in CGT on the gain. A usual strategy to reduce the liability, if you are married, is to ensure that the house is put into the joint names of your spouse and yourself before you sell the property. This way you can both offset your annual allowances against the gain.
4. Making use of principal private residence exemption
All gains on property are taxable with the exemption of the home you live in which the tax man calls your principal private residence. If you own more than one home you can elect which you wish to class as your primary residence, provided there is some evidence that you actually reside there albeit shortly. If you live for even a matter weeks at any stage in your “second” home this may enable you to write off the last three years of capital gains when you come to sale. However, you must elect which will be your primary residence within two years of the purchase of one of the various properties you own. Having made your choice, you can change it but if you fail to elect the opportunity is lost.
5. Live in the property for a longer period
Any extended period you live in the property as your main residence reduces the capital gains tax bill accordingly. It is important that you regard the property as your main residence and that postal and electoral details for the period reflect the position. The time is apportioned. If you own property for 17 years and live in it for 12 years you will be liable for 12/17ths of the tax bill plus a further 3 years exemption wiping out 15 years worth of gain in the property value.
6. Maximising the rent a room scheme
Similarly if you class successfully your second home as your primary residence and you rent one room in that second property you may be entitled to the rent a room scheme. This provides a tax free income rental and potentially you can get a further £40,000 allowance to offset against any gain. A husband and wife both receive this allowance and can write off a further £80,000 of the gain provided they are joint owners.
7. Use your other losses
If after this you are still facing a tax bill, look at your other assets and not least your share portfolio to see if you are sitting on any losses. If you sell these shares in the same tax year and crystallise the loss, this can be offset against the property gain.
8. The holiday cottage might qualify for Business Property Relief from Inheritance Tax
A recent tax case of Pawson (deceased) -v- HMRC has ruled that a holiday cottage letting qualify for business property relief, the effect of which, is to exempt fully the value of the property from the tax charge on the death of the owner. There needs to be a hands on approach with the letting so that the ownership can not simply be regarded as holding an investment and instead regarded as a business asset within the meaning of the law. If you are actively letting your holiday cottage then it is important to seek legal advice at an early stage to ensure that the facts are presented in the best possible light.
The message here is that tax on second homes (and rented properties) can be a significant problem but that in many cases it is possible to reduce the tax liability to manageable proportions or to avoid it altogether. To do this effectively it is important that you put planning in place as soon as possible.