By Simon Misiewicz
Are you looking to flip properties?
Did you know that you could pay 40% tax on that flip?
Different types of property tax to pay
I hear a lot of horror stories where investors think that they will get Capital Gains Allowances and pay just 18% tax on the profit made. Sadly, there is a criteria that must be met to ensure that CGT is paid rather than income tax.
Capital Gains Tax (CGT)
This is where you pay tax on properties that you have purchased, refurbed, rented and then sold.
Income tax is paid when you purchase, refurb and sell a property. Please note that the property would not have been rented. The tax you pay will therefore be based on your total income.
If you sell a property the maximum amount of tax you pay is as follows:
- Personal income tax 20%/40%/45%
- CGT 18%/28%
- 20% corporation tax
Special purpose vehicle (SPV) — limited company
I would advise that people set up a limited company as a special purpose vehicle (SPV). The reason for this advice is because:
- A limited company limits the financial risks to the limited company, not your personal assets
- As a limited company you are not tying yourself financially to any joint venture partner
- There is a perceived enhanced reputation by using a limited company
- It is more tax efficient to have a limited company that is only taxed at 20% compared to a maximum of 45% income tax as an individual.
Entrepreneurs’ relief to mitigate CGT
You can claim entrepreneurs’ relief when you sell a property within a limited company that has paid corporation tax.
So, how much tax do you pay? You will pay 10% tax by making use of entrepreneurs’ relief rather than 18%/28% CGT.
Here is the process of setting up a limited company:
1 – Agree who are going to be the investors. They agree to put in £1 shares each
2 – Agree the amount of money that is to be loaned to the company
3 – Set up a limited company
4 – Set up a limited company bank account
5 – Ensure that bookkeeping is neat and tidy by using online software such as Xero
6 – Carry out the business/property transaction, making sure you get invoices for all the money that you spend
7 – The company is taxed at 20% of any profits made
8 – Pay back any loans made
9 – The company is closed down and remaining cash is distributed to the shareholders
10 – Shareholders are taxed at 10% entrepreneurs’ relief on closing down the limited company, after receiving the CGT allowance.
Example of entrepreneurs’ relief
1 – John and Jim agree to set up ABC Limited with £1 equity each
2 – They both agree to put in an additional £49,999 each as a loan
3 – An agreement is formed and signed
4 – ABC Limited is born on 3rd January 2015
5 – Bank accounts are set up so that one person issues a payment to be made and the other person has to authorise it. This ensures financial control of the money within the business. It also ensures that the two agree how the money is spent in advance
6 – Jim agrees that he should look after all the paperwork
7 – They buy a property for £100,000 and sell it for £150,000. The business has therefore made £50,000
8 – At the end of the financial year, 2nd January 2016, they work out that the profits are £50,000 as above and their accountant informs them that the 20% tax of £10,000 needs to be paid nine months later. This means that the business will have £140,000 (£2 equity plus £99,998 loan + £40,000 profit less £10,000 tax bill) left in the bank after the tax has been paid
9 – The company pays back the two loans of £49,999 (each). This leaves the company with £40,002 (£40,000 profit after tax and £2 equity shares)
10 – The balance of £40,002 is split between the two brothers. Each therefore gets £20,001 (£20,000 share of the profits plus £1 equity)
11 – Jim and John do their self assessments after closing the company down and they claim entrepreneurs’ relief at 10%. Tax is calculated as follows:
£20,001 profit plus the £1 equity
(£1) less the equity involved
(£11,000) less Capital Gains tax allowance
£9,000 taxable profit
£900 tax to pay (10% of the £9,000)
Please note to qualify for entrepreneurs’ relief the following must apply:
– you’re a sole trader or business partner
– you’ve owned the business for at least one year before the date you sell or close it
– you sell or dispose of your business assets within three years of selling or closing the business
Next steps to using entrepreneurs’ relief
If you want to understand how to implement this strategy or to discuss other finance/tax questions then please book some time with us using the below calendar:
If you are looking for a new accountant then please book some time with us using the below calendar. Please note that this booking is to describe our services and will not be used to discuss your personal tax affairs.