Many people who start out in property call themselves investors but are they property investors or property traders?
In my experience they can call themselves what they like but it is the facts of the case and how you carry out your business that will determine whether the taxman (HMRC) sees you as an investor or a trader so beware and to make matters worse there is always a muddying of the waters.
A property investor will hold properties as a long term investment. They will be the assets of the business and bought a) to produce rental income and b) over time capital growth. Don’t believe what you read in the papers, it’s a fact that property has historically doubled every 7-10 years despite some wild fluctuations within that period. Rental income is accounted for on an annual basis to 5 April each year and property disposals dealt with as capital gains and with use of the annual exemption (currently £10,100 per person) a jointly held property could show a healthy profit with no capital gains tax payable.
- Profits are subject to capital gains tax
- Use of annual capital gains tax exemption
- Possible use of principal private residence relief (PPR)
- Totally exempt for non UK residents
- No National Insurance on profits
- Not good for abortive expenditure (surveys, finance applications etc)
A property trader will purchase with a view to making a quick short term gain through a refurb and then flipping the property on. It’s unlikely that the property will ever be let out and the profit is made when the property is sold on for a higher price. Here any profit would be subject to Income Tax and National Insurance or Corporation Tax if held within a limited company.
- Better scope for claiming abortive expenditure
- No use of annual exemption
- Greater relief for interest costs
- Chose any year end
- Losses used against other income
- Profits taxed at marginal rates and attract National Insurance if self employed
- Profits charged to corporation tax if a limited company.
So given the tax treatment it is clear why people call themselves investors not traders though the key question is whether any profit is a capital gain or a trading profit? It’s not clear cut and naturally keeps HMRC on their toes looking for traders not investors as that will typically bring about more tax revenue. Something they are keen to do at the moment.
It is not your choice but in reality is determined by how the business is run and also on your intentions at the start of a project but how do you prove your intentions to HMRC and what if I change my mind?
- Start with making a note as to why you bought a property. Drop a line to your accountant or legal advisor. A business plan would demonstrate what your plans were. That’s a great start and if for some reasons plans change then document them as well. There may be a perfectly good reason why a long term investment was sold short term and documentary proof will help you argue your case with HMRC. Your long term investment in a student flat in Cambridge could swiftly move from long term to short term if little Jimmy fluffs his A levels and ends up somewhere less academic!
- Beware of the frequency of transactions. If a property is bought and sold every now and then, that would suggest an investor but if you are buying frequently and selling on that would suggest a trader.
- HMRC also get quite excited about the number of transactions in a given period. In theory there is nothing to stop you buying a house, improving it and moving on and making full use of the PPR exemption. Do this every six months and HMRC may get excited and would suggest property trading. After all moving is one of the most stressful things you can do so why would you do it every six months?
- How are the transactions financed? Mortgages and long term finance are more indicative of investment, though nowadays some see an ERC as part of development costs!
- Letting out a property is indicative of an investment not a trade.
- How long a property is held for may also influence HMRC, though again there is no hard and fast rule on this one.
So in summary call yourself what you like “Supreme Allied Property Developer”, “Joint Chief of Staff” but remember what your intentions and actions are will determine whether HMRC see you as a property investor or property trader.
Get that right and you will keep a lot of money out of the taxman’s hands.
Happy investing or is that trading!
Further information on this topic can be obtained from Iain@iainwallis.com