By Louise Misiewicz
Updated and relevant for tax year 2017/18
Are you looking to flip properties?
Did you know that you could pay 40% tax on that flip?
Have you heard of entrepreneurs relief?
Before we go into the detail you can download our flip tax calculator that shows you how much tax you will pay if you flip a property be it in your personal name (income tax or Capital Gains Tax) or in a limited company.
Different types of property tax to pay when selling properties
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. The tax rates for properties sold after being rented out is 18% for basic rate tax payers and 28% for high rate tax payers.
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. The tax rates are 20% for basic rate tax payers, 40% for high rate tax payers and 45% for additional rate tax payers.
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.
Download our tax efficient property investment guide for 2018 here
Entrepreneurs relief to mitigate Capital Gains Tax (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 2018, they work out that the profits are £50,000 as above and their accountant informs them that the 19% tax of £9,500 needs to be paid nine months later. This means that the business will have £140,500 (£2 equity plus £99,998 loan + £50,000 profit less £9,500 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 £40,502 (£40,500 profit after tax and £2 equity shares)
10 – The balance of £40,502 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:
£20,251 profit plus the £1 equity
(£1) less the equity involved
(£11,300) less Capital Gains tax allowance
£8,950 taxable profit
£895 tax to pay (10% of the £8,950)
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
Targeted anti-avoidance rule (TAAR) against flipping properties in limited companies
Please note that from 6th April 2016 HMRC are preventing property investors and landlords from regularly opening and closing down limited companies to take advantage of the above tax initiative. You can read more about this on their website.
All of the following conditions must be met:
- A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up
- B: the company was a close company at any point in the two years ending with the start of the winding up
- C: the individual receiving the distribution continues to carry on, or be involved with, the same trade or a trade similar to that of the wound up company at any time within two years from the date of the distribution
- D: it is reasonable to assume that the main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to Income Tax.
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