This is a strategy that we have been hearing a lot
about recently. Essentially, the proposition is that if you own a
buy to let property you can release equity from it by remortgaging
in order to provide yourself with spending money, and as long as you
never sell the property, you will never have to pay CGT. It seems
that this idea is being promoted in some quarters as the “golden
key” to becoming wealthy through the property market!
It is true that there is no tax to pay when you release equity by
remortgaging, whereas there may well be CGT to pay if you sell, so
the “never sell – never pay tax” proposition is I suppose true as
far as it goes, but before you decide to adopt this strategy there
are a few potential pitfalls to consider:
The CGT Trap
This was covered in detail in an article in December 2005 by Daniel
Feingold and Amer Siddiq: taxarticle47.shtml Basically, the problem
arises when the level of debt secured against the property is such
that if you sell it, once you have repaid the debts you will not
have enough of the sale proceeds left to pay the capital gains tax
charged on the gain you will make on the sale.
But the whole idea of the strategy is not to sell the property,
isn’t it? True, but you never know when circumstances may dictate
that you want to sell – or for that matter, the property may get
caught up in some development project and be compulsorily purchased.
A successful business needs to be flexible if it is to survive and
getting yourself into the CGT Trap is the opposite of being
flexible.
Relief for Interest Paid
If you own a property and let it, you can release equity from it up
to its market value on the day you first let it and the interest
payable on the borrowings can be deducted from the rent received for
tax purposes.
If you release more equity, however, so that the loans become
greater than the market value of the property when it was first let,
the interest on that additional borrowing will not qualify as a
deduction for tax purposes – unless you use the money to fund the
purchase of another property.
Rental Income
Because of this limitation on the interest you can deduct from your
rental income, as property values rise (and you follow your plan of
releasing equity accordingly) and rents rise as well, there may come
a point when you are in the unpleasant position of making a taxable
profit on your rental income from the property, while your actual
expenses (including the interest on the equity releases above the
original market value, which you cannot claim as a deduction against
the rent) are greater than the rental income you receive. You will
be paying tax on a “profit” from the property while you are in fact
making a loss!
Inheritance Tax
Death is one way out of the CGT trap, of course:
When you die, inheritance tax (IHT) is charged on the net value of
your estate after deducting any debts. There is no CGT on death, but
for CGT purposes your heirs are treated as acquiring your property
at its market value on the date of your death.
In other words, if you die owning a BTL property you bought for
£100,000, which is now worth £300,000 and has a mortgage of £250,000
secured against it, for IHT purposes the net value of this would be
only £50,000 (IHT of £20,000 payable, assuming the legacy is not
exempt for any reason and you have used up your “nil rate band” on
the rest of your estate). Your estate now has a base cost of
£300,000 for the property, so if it is sold immediately the estate
will clear £30,000 from the deal:
| Sale proceeds | £300,000 |
| Less IHT | (£20,000) |
| Less mortgage repaid | (£250,000) |
| Leaves cash | £30,000 |
Caveat The IHT rules concerning debts can be quite complicated, and
in some cases the above would not apply. For example, if you had
used the equity released to make a gift to one of your heirs, it is
possible the debt would not be allowed as a deduction from your
estate. In a simple case, however, where the equity released is used
to fund your living expenses, the above example should hold true.
When Not to Sell
There are some situations where not selling a property makes perfect
sense – indeed, where it would be foolish to do so:
Buster and Izzy are a young married couple, living in their house in
the Westcountry with their new baby. Buster’s employers want him to
move to the Midlands, so he and Izzy sell their house (no CGT as it
is their main residence) and use the money left over after paying
off the mortgage (and the estate agency fees!) to fund the deposit
on a house at the new location. The equity in the old house has gone
up since they bought it, and so they are pleased to find that they
make a profit of £75,000 on the sale of the old house.
If, instead of selling the old house, they had released equity from
it to fund the deposit on the house in the Midlands, and let the old
house they could have deducted all the interest on the mortgage on
the old house from the rental income they would have received. As
the old house appreciated in value, they could have continued to
release equity (up to the market value on the day they first let it)
and deducted the interest from the rent. In a short time they would
have found themselves in the same financial position they were in
after selling the old house, but with an income producing asset (the
old house) that would still have been appreciating in value and
which in the future it would have been possible to sell with little
or no CGT to pay, given a little careful tax planning.
Beware of Simple Strategies!
“Never sell – never pay tax” has a catchy ring to it and in many
circumstances there is quite a lot of truth to it, but like many
“simple” ideas it has severe limitations.
I come across a lot of “sound bite” tax advice where a simple
proposition is presented as the way to minimise tax, and in most
cases, as here, my reaction is “Well, yes, but…” and the “but”
usually involves several unpleasant side-effects of the strategy
concerned.
Oscar Wilde said “The truth is rarely pure and never simple” and
that is certainly true about tax.
Let me end with my own “sound bite”:
In tax planning, if you think the solution is simple, you probably
haven’t understood the problem!
About James Bailey
 |
James Bailey is a Chartered Tax Advisor (CTA) and an integral part of the Property Tax Portal team. He offers a special rate tax advisory service on any aspect of UK taxation. |
|
How to Avoid Property Tax by
Carl Bayley Overview: This highly acclaimed guide is widely regarded as the definitive property tax bible by landlords, property developers and the media. How to Avoid Property Tax – now in it’s 8th edition – is packed to the gunnels with invaluable tax planning advice, useful strategies and general tax saving tips which cannot be found in any other publication. Learn how you could be paying far less income and capital gains tax on all your property assets and investments. More Information / Buy Now |
|
|
FREE - Tax Strategy Audio Tutorials
If you want to boost your property profits,
minimise taxes and avoid common tax traps that
investors fall into then listen to these FREE 10
minute property tax strategies/secrets/tips provided
by
propertytaxclub.co.uk. These strategies will
teach you: |
|
Information here is general only & believed to be correct, though we cannot guarantee it, nor do we accept any liability if you act or fail to act on this information. Always seek professional advice before making decisions. Investments can go down in value as well as up over time.
© Copyright LandlordMONEY™ 2008 - all rights reserved.
