Understanding Taxation On Property Investment & Property Trading

Make sure you document your intention

A recent tax case has emphasised the importance of maintaining contemporaneous documentation to evidence the correct tax treatment on a property disposal.

The taxation treatment can vary significantly depending on whether the taxpayer is deemed to be carrying on a property trade or a property investment business.

As well as receiving rental income, investors also make money from capital growth when they eventually sell a property, and this is subject to capital gains tax. Property traders also make money when they sell, but because buying and selling is their business, they pay income tax on the proceeds of the sale.

Investment property tax

You might think matters are simpler when a property is owned by a company and not an individual – after all, corporation tax is due on both income and capital profits, but this distinction can still create different tax outcomes.

This was the case with Terrace Hill (Berkeley) Ltd v HMRC. The company had brought forward capital losses which were offset against its property disposal profit, as it treated the property as an investment. HMRC argued that the property was in fact held for trading purposes and so these capital losses could not be utilised.

The company had bought the property in 2000 and completed development in 2003. Two years later, in May 2005, it let the property, but only for a few months and it was sold that September.

Despite the short rental period, the company successfully argued at tribunal that the intention had always been to keep the property as an investment that would provide rental income to the group. But as the rental income was less than expected, it decided to sell.

Despite the short rental period, and the fact that the company was part of a property development group, the tribunal found in favour of the company. It decided there was enough evidence in the form of detailed minutes to support the argument that the property was always intended as an investment. A compelling point was that the accounts treated it as an investment. And the Chairman had strong accounting knowledge and could support this before the tribunal.

This case shows that HMRC is actively challenging the taxpayer in this area. It also shows that keeping clear documentation on your intention for a property can be critical in the event of an HMRC challenge.

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. For example, a property could be sold after only two years, but if board minutes show that the original intention was to hold it long-term and if the offer to buy was unsolicited, there is a good case for treating the transaction as an investment disposal.

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