Capital Transaction Vs Trading transaction

Buying property seems to be the easy step when it comes to property investment, and relatively speaking, so is selling property. However, it goes without saying that you don’t want your profits eaten up by the taxman, and that’s when selling property can be a little bit complicated.

In principle, I always recommend getting a good accountant that has had plenty of experience with property sales, so he/she can calculate the best options for you financially. The tax guides on property Investment Project are simply here to make you aware of your options, and nothing more. I’m far from a tax guru when it comes to property; there are specialists out there that can explain the fundamentals better 10 fold.

Tax Treatment

Broadly speaking, there are two options as an individual that your actions of selling property can be classed under by Inland Revenue, it’s either a “capital transaction” or a “trading transaction”

Property Trader

If the intention in purchasing the property was to develop and sell the property with the intention of making a profit, the Revenue would be likely class you as a property trader. A property trader would be subject to income tax on any profit.

Capital Transactions

Capital transactions are usually retained for property investments, eg an individual purchasing a property to rent out. The disposal of a property investment would be subject to capital gains tax (‘CGT’) on any gain arising.

Capital Transaction Or Property Trader?

In some circumstances trader treatment can be beneficial, particularly as it allows for a greater offset of expenses, for example any maintence work or extentions can be used against profit. Whether the Revenue would agree that this is a capital transaction will depend on a number of issues:

  • Whether you have undertaken this kind of activity before
  • How long the property will be held before selling
  • Will the properties will be rented out
  • Whether you anticipate doing this again

If the Revenue class your action as capital transaction, this would allow you to take advantage of the various CGT reliefs such as taper relief, annual exemption, principal private residence (‘PPR’ relief) etc and therefore for most people this will be the most attractive treatment.

A key issue would be how you treated the property after development. If you were to sell a property within 12-24 months, there would be a good argument that income tax treatment would apply because you will be seen as a trader for selling quickly after purchasing. There would then be fewer reliefs, and no benefit would be obtained from living in the property as you couldn’t claim PPR relief. In order to rebut any such argument, you would need to persuade the Revenue that the property was purchased with the intention of living in it, or getting tenants, but due to unforeseen circumstances, such as personal/financial issues, your plans changed and you were forced into selling the property.

If you were to lease the property for a number of years after development, or if this was an isolated activity you would have a good argument that the property was not purchased/developed solely to resell at a profit, and CGT should be applied.

If you were classed as a property trader, you would also need to consider any national insurance charge which is set at 8% on profits within the upper national insurance charge limit and 1% above this. There could also be a liability to national insurance charge on the profits if you were classed as a trader.

First Time Buyers Should Argue For Capital Treatment

For most people that are just starting off it would be advisable to argue for capital treatment, assuming you have some grounds to support your stance. The gain would be calculated as the disposal proceeds less the costs of acquisition/development and enhancement (eg refurbishment expenditure). You would be allowed a deduction for the incidental costs of acquisition and disposal (eg stamp duty, estate agents fees, conveyancing fees). You would then obtain the benefit of the annual exemption on disposal, and taper relief.

You could also consider occupying the property and claiming PPR relief. This is very advantageous and 12 months occupation could eliminate three years worth of the gain. If the property was clearly purchased, developed and then immediately sold none of these reliefs would be available.

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1 Comments- Join The Conversation...

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Bill 19th January, 2011 @ 22:01

A reasonable potted version of the tax implications but two small points in that it can be advantageous to convince HMRC that you are a proerty developer if
(a) you had large amounts of loan interest that would not otherwise be allowed as loan interest is not allowed in calculating a capital gain
(b) you make a loss in times of property crashes and trading losses can be set off against other income whereas capital losses on properties can only be set off against other capital gains in the year or carried forward to set off against future years gains

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