The distinction between dealing and investing in property is often quite clear cut. For example, if you buy a house to rent out, you are probably doing something different from someone who buys a house to renovate and then sell. But what about those grey areas?
There are two main ways to classify a property transaction.
One is to apply the badges of trade test. These are a series of questions that ask whether a particular activity is undertaken for profit or gain. It is not necessary for a transaction to have all the badges in order to be regarded as dealing or developing and clearly some badges will carry greater weight than others, depending on the facts of the case.
The second method is to look at the purpose of the transaction. If the primary purpose is to make money, then it is an investment. If the primary purpose of the transaction is to generate income, then it is a trade.
The situation will, therefore, always need to be considered carefully in light of all the facts and taxpayer’s intentions.
In terms of the distinction between property dealing and property investment, normally the main considerations are the profit seeking motive, the frequency and number of similar transactions and the length of ownership.
Whether a property disposal is a trading
, or an investment transaction has an impact on whether the business is a sole trade, partnership, company or as capital as detailed below:
Income tax v capital gains tax
For individuals, the main difference between acquiring a property as a trading transaction or as an investment is the tax assessment of the profit on any future sale of the property.
If the sale is made as part of a trade, both income tax and national insurance will be payable on the profit. If the sale is of an investment property, the profit is subject to capital gains tax. This could mean the difference between a higher tax and NIC charge on income compared to the lower tax charge on capital gains.
Being a trading business rather than holding property as an investment activity can also impact on the availability of business asset disposal relief.
If the property is likely to be a trading transaction, it may be beneficial to hold the property through a company as the rates of corporation tax are lower than income tax and interest restrictions may not apply. It will be important to plan the extraction of the property to reduce any double tax charges.
Although the rate of tax on the chargeable gain on an investment property transaction is the same as the rate on profits on a trading disposal, the method of calculation of the chargeable profit and reliefs available are different. If a company holds a property as an investment, any expenses will be management expenses rather than trading and loan relationship deficits will be non-trading deficits.
As with property held by individuals, being a trading business rather than holding property as an investment activity can also impact on the availability of business asset disposal relief on the shares in the company. When we come to considering Inheritance tax planning and business sales, this can have a big impact.
If the property were to be sold at a loss, it would be more advantageous for the sale to be a trading transaction as trading loss relief is more generous than capital loss relief for both individuals and companies.
For individuals, trading losses can be relieved against other income in the year of the loss or the previous tax year (known as ‘sideways loss relief’). However, such losses fall within the cap on unlimited income tax losses. The loss can also be carried forward to set against trading profits of future years.
For national insurance purposes, the trading loss may also enable the taxpayer to claim tax credits (or increase an entitlement to tax credits).
For corporate businesses, there is flexibility for trading losses to be set against current and prior period profits, group relieved or carried forward. Capital losses can only be set against capital gains or carried forward.
Property business and business property relief
Where the individual taxpayer is regarded as engaged in the trade of property development, rather than as a property investment, their interest in the business attracts business property relief (BPR) for inheritance tax purposes. Shares in a property development company also qualify for BPR.