Popular television programmes such as “Homes under the hammer” have led to a huge rise in popularity in the idea of buying property, doing it up and selling it on for a nice tidy profit. According to government statistics published in August 2021 the average house price in England now stands at £284,029, a staggering 13.3% up on a year ago (Figures to June 2021). Is it any wonder with most renovations taking several months that even without adding value to a property the inbuilt inflationary profit continues to attract more and more individuals to this apparently low risk but lucrative area in business.
However there are many potential pitfalls for the unwary and key amongst them is tax. Here below are 10 of the most common tax pitfalls or missed opportunities we see with our property developers and particularly those who are new to this type of business.
1. Wrong legal entity
The simplest and one of the most common errors first time property developers make is to do their first project in their personal names. They assume, incorrectly, that provided they don’t take the profit from their business it can be rolled up and used in their next venture. Unfortunately this is not the case and an individual will be taxed at their top rate of income tax. So an individual who is salaried on £50,270 (tax year 2021/22) and then makes £20,000 profit from property development will pay almost £9,000 in tax and national insurance. By simply having a limited company this liability could be reduced to £3,800, a saving of £5,200.
Do note that limited companies are not always the right solution. There are additional running costs and if the project is a one off there may be no savings at all by going limited so please seek professional advice.
2. As a property developer your income is assessed as a trade and not as a capital gain
This is a classic mistake made by many individuals who first go into property. They assume because they are selling a property that the profit will be liable to capital gains tax. This is however only true if the property is held as an investment for a period of time and either used personally or rented out. If the property has been bought to do up and sell at a profit then the profit is assessed as trading income and liable to income tax and national insurance if bought personally and corporation tax if bought via a limited company. So instead of paying 18% or 28% capital gains tax you could be paying 20% or more likely 40 or 45% income tax together with a potential national insurance liability.
3. Mixing your own personal property with your property development business
This is another classic mistake. When most individuals sell their main home there is no capital gains tax because of so called principal private residence relief (PPR). There are however two common pitfalls in this assumption.
Firstly you may simply decide to live in the property you are renovating and claim PPR relief on the profit. Many individuals have done this but unfortunately HMRC (the tax man) is wise to this and where this happens on multiple occasions HMRC may look to disallow the PPR relief and tax the profit as a trade.
A second problem can arise where you seek planning permission on your property to build say a second home on your site (e.g. a barn conversion) or convert your home into flats etc… This could potentially greatly enhance the value of your property. This uplift in value should still be covered by your PPR exemption provided you sell the property with just planning permission and have not carried out any work on the development. As soon as you put a spade into the ground this uplift could become taxable.
In brief if you look to exploit your home to make a profit then the likelihood is that tax is payable. Therefore seek professional advice to see if there are ways to mitigate or avoid this liability. Invariably there are!
4. No construction industry scheme
Almost without exception most property developers who fail to take advice do not set up a construction industry scheme (CIS) to deduct CIS tax on the labour element of any subcontractors who work for them. Basically if you engage labour on a property development whether as a sole trader or a limited company you have to stop 20% tax on the labour element unless the subcontractor has an exemption certificate (30% tax is stopped if the subcontractor is not registered as a CIS subcontractor with the tax man). Labour includes groundworkers, bricklayers, electricians, plumbers, double glazing firms, scaffolding firms, roofers, plasterers, kitchen fitting companies etc….
Failing to register could lead to penalties in the tens of thousands of pounds. This can happen even when all the subcontractors are registered as self-employed and have paid their own taxes.
Please note that there is a distinction between property investment and property development. A property investor is someone who buys property for its rental return and not to buy and sell. The property investor will not have to operate a CIS scheme in most cases unless they carry out significant construction work.
5. Incorrectly paying your workers
It goes without saying paying your workers cash is a no no. Not only is it illegal but often a false economy as their expense cannot be claimed as a deduction against the business profits, potentially costing an additional 19% tax for companies and 40%+ for individuals.
Furthermore if you do get heavily involved in property development and “employ” someone long term you have to consider whether they should be taxed as an employee or can be treated as self-employed. Make sure all your subcontractors are genuinely self-employed if that’s how you are treating them. Anyone who is unskilled or working exclusively for you and under your instruction is likely to be deemed an employee and should therefore be taxed as an employee with the requisite national insurance and pension costs to add. Failure to engage a worker correctly can result in huge tax liabilities as well as penalties and interest.
6. Not claiming finance costs
In most situations financing is fairly straight forward. A loan is taken out on the purchase of the property for development and clearly the interest charged on that loan can be offset against the profit from the business. There are no mortgage interest restrictions like there would be on the interest on a mortgage taken out for a property bought personally to rent out.
However what about the monies for the deposit? Has this come from savings or from a remortgage of your main home? The interest on personal borrowing taken out to provide the seed capital for the business – the set up costs, the deposit, plant and equipment is often overlooked.
7. Not charging interest on your loans to your company
If you set up a company and borrow personally to fund part of the set up then the monies you pass to the company goes in as a loan from the director/business owner to the company and interest can be charged by the individual at rates as much as 10% per annum. Charging interest on a loan can be highly tax efficient. There are a number of anomalies within the tax system which can be exploited and this is by far a more tax efficient way of extracting profits from a company compared with salaries or dividends.
One word of warning – to extract interest from a company as an individual you have to complete a form CT61 and deduct 20% tax from the interest payment. However if your loan exceeds £10K then invariably there is a significant tax saving even after professional fees to complete the form CT61.
8. Not claiming for all expenses you are entitled to.
We mentioned interest above but there are so many expenses you can claim which are frequently overlooked. Any business mileage carried out on behalf of the business – going to auctions etc… can be reclaimed. If you use your own car this can be as much as 45p per business mile.
Mileage is only the start. Talk to your professional advisor, they will have a list of expenditure often overlooked such as use of home office, subsistence, entertaining, trivial benefits etc….
If you have a limited company drawing small salaries can also be tax advantageous.
9. Ignoring VAT
For most property developments VAT is not an issue as the sale of property is generally exempt which means that VAT cannot be charged on the sale but no VAT is recoverable on purchases. However property development isn’t just doing up a slightly run down house and selling it for a profit.
New builds, conversions from commercial to residential, conversions of a premises to different residential use, and properties empty for two years all have opportunities for substantial VAT savings. This is where talking to a professional who is used to property development really pays off. Anything out of the ordinary needs to be examined to see if there is an opportunity for VAT savings.
10. Forgetting your partner!
If you are going into property development make sure you look at your family unit and ensure that the business is set up in the most tax advantageous way by ensuring that you and your partner utilise your personal allowances and basic rate tax bands. This is simple tax planning which again is often overlooked.
There are many other tax traps to avoid but the above are the most common. Property development can be extremely lucrative but as you can see there are many pitfalls so we recommend if you are going into property development you seek professional advice. The figures are invariably big and missed opportunities or mistakes can be expensive.
If you are a client of Friend & Grant and need advice on property development please contact Mark Friend.
The content in this blog is correct as at 6 September 2021 See terms and conditions.