Flipping property seems to be all the rage right now and can be a great way to turn a profit when done right. However, it’s surprising to see how many homeowners are still unaware of all the legal implications that come with selling property for profit. Let’s take a closer look at the legal aspect of property flipping and what investors should expect.
Capital Gains Tax and Property Flipping
Capital gains tax is subject to much confusion among property flippers and many have and are still trying to use loopholes to evade taxation. However, the government has instituted a variety of measures that aim to reduce tax avoidance and all of the previous loopholes that allowed homeowners to avoid capital gains tax when selling a second home. Contrarily to when selling your main home, capital gains tax has to be paid when selling a second home. However, a special tax break used to allow people who utilised that second home as a residence to reduce their tax bill.
Private residence relief once allowed second home owners to claim relief for up to 36 months on any property that they owned and sold for profit even if they didn’t live there during this period; as long as they actually lived in the property at some point in time. The goal of the tax break was to allow homeowners to avoid the fees if they were struggling to sell their property due to market conditions and moved to a new home before they were able to sell. However, home flippers eventually caught up with the loophole and used it to avoid taxes by switching their main residence to the one being sold. To curb the practice, the period of exemption was cut from 36 months to 18 months.
Trade & Income Tax
If you’re thinking of buying a leasehold or freehold property, you cannot automatically assume that the gain on the sale will be subject to capital gains tax. Your tax rate will be much higher, 45% plus national insurance to be exact, if it is developed and then re-sold as a “trade”. You will only be eligible to the 28% CGT rate if the property is bought as a long-term investment or with the intention of renting it out.
Also, if you’re a real estate developer and are either a partner, sole trader or a limited company, you will not be paying CGT when selling a property. Sole traders and partners will need to pay income tax and limited companies will be subject to corporation tax.
How Do I Know if I’m Trading?
Knowing whether you’re involved in a trade is not always easy. The courts will determine if you’re trading by taking a number of considerations into account; these are referred to as the “badges of trade”. They will look at things such as length of ownership, the number and frequency of similar transactions, the modifications that were made to the property, and the reasons for acquiring the property.
One of the most important badges of trade is your initial intention when you acquired the property. If your intention was to quickly renovate a property with the sole intention or reselling it for profit, then chances are you’re involved in a trade as a property developer.
What Are the Tax Effects?
If you decide to buy a run-down property for £350,000, make a few repairs and some renovations for £30,000 and then sell the property for £430,000, you have made a profit of £50,000. The amount taxable will depend on whether you’re engaged in a trade or not.
If you are indeed engaged in a trade, you will have to pay income tax plus national insurance. Any renewal, repair, improvement, or renovation will count as acceptable expenditures when calculating your profit.
But if you’re not engaged in a trade, you’ll be subject to capital gains tax. It’s important to note here that you won’t be able to deduct things like renovation costs and repairs that are not qualified as capital improvements and so the amount taxable might be as high as £80,000 and not £50,000.
Investing in Commercial Property
If you are thinking about investing in commercial property, then you’ll have to familiarise yourself with the commercial conveyancing process. If you are thinking of buying property, your solicitor will start by investigating the property’s title and carrying out pre-contract searches. Once the title, draft contract, and searches are received, your solicitor will be responsible for raising any enquiries resulting from answers to the CPSE enquiries and the searches.
If there are no issues with the enquiries, you will receive a report letter along with documentation for your signature. Once your solicitor has a clear deposit and received these documents, they will arrange an agreement between both parties on a date for the exchange of contracts and completion. At this point, you will be entering into a legally binding contract.
Once this is done, your solicitor will give you a financial statement that will allow you to pay the balance in order to complete the transaction. If this isn’t the first property you have purchased, you will need to pay a Stamp Duty, and then the transaction will be registered.
The commercial property buying process can be very complex and, because of this, it is a good idea to work with a qualified commercial property lawyer to guide you through each step. Firms like hjsolicitors.co.uk specialise in commercial conveyancing and have years of experience under their belt. Don’t just assume that all solicitors are created equal, though. Only a good solicitor will ensure that the process goes smoothly and work on your behalf.
So, if you are thinking of flipping properties, make sure that you familiarise yourself with the entire process and understand the legal aspects and costs involved as well. This way, you’ll be able to understand what you’re actually getting into and avoid unpleasant, and potentially costly, surprises down the line.