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Saturday, 27th April 2024 |
| Tax issues for property investors |
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| Investing in property holds many taxation implications, yet as Paul Mee shows, careful planning can still enable tax efficient investment. |
There have been several recent changes of significance to the property investor. These include the types of available property investments and the issue of undeveloped land. This article is designed to give an overview of those issues. The first issue is to list the range of tax based property investments available to investors, the second highlights some issues that affect tax based investments and the third discusses the tax implications of acquiring and developing property. The list below is written from the perspective of an investor rather than a person using the building for the purposes of his/her own trade, in which case higher allowances than those stated may be available. Also, there are numerous conditions that apply to each relief that have not been included in the text.
Types of property investment
Hotels, holiday camps & holiday cottages: Annual industrial buildings allowance for hotels or holiday camps of 15 per cent for first 6 years and 10 per cent in the seventh year. Capital allowances of 10 per cent per annum on registered holiday cottages. No capital allowances for grant aided hotels after 20 March 2001. Board Failte certification required for hotels, work on which commences after 6th April 2001.
Multi-storey car parks: Assuming that there is no entitlement to double rent allowance, capital allowances are available to lessors of up to 50 per cent in year one, with 4 per cent annual allowance thereafter. Relief applies up to 31 December 2002 provided that at least 15 per cent of the total cost of the project has been incurred by 30th September 2001.
Nursing homes: Capital allowances on private nursing homes registered with a Health Board, at the rate of 15 per cent per annum for 6 years and 10 per cent in the seventh year.
Private convalescence facilities: Facilities to be used as an alternative to hospital care and must be approved by Health Board. Capital allowances are the same as those available for nursing homes.
Private hospitals: Hospitals operated by a charitable body and certified by a local area Health Board. Scheme is subject to EU clearance and subsequent Ministerial Order. Capital allowances are the same as those available for nursing homes.
Childcare facilities: Capital allowances of 100 per cent available in year one, subject to appropriate Ministerial Order being issued on receipt of EU clearance, for building used as childcare facility.
Student accommodation: Section 23 type relief available for expenditure incurred up to 30 March 2003 on rented residential accommodation for third level students. Expenditure may be offset against all Irish rental income.
Town renewal scheme: Section 23 relief on rented residential accommodation. Capital allowances on commercial / industrial buildings consisting of initial allowance of 50 per cent and annual allowance of 4 per cent per annum thereafter. Relief on commercial and industrial buildings is awaiting EU approval. Buildings must not be used in certain sectors.
Living over the shop scheme: Relief for expenditure on specific type commercial building, provided expenditure also incurred on residential accommodation on upper storey. Expenditure incurred up to 31 December 2004 may qualify for relief. Capital allowances for commercial building consist of 50 per cent initial allowance plus an annual allowance of 4 per cent per annum thereafter. Section 23 relief is available on residential expenditure.
Park & ride facilities: Various capital allowances available for buildings or structures, served by a bus or train, which provide parking space for vehicles of the general public, who intend to continue a journey by bus or train. Qualifying period for expenditure is 30 June 2002. Capital allowances available to lessor consist of 50 per cent initial allowance and 4 per cent annual allowance thereafter. Commercial premises and rented residential accommodation located on the site of the facility will also qualify for relief, subject to certain limits. Relief is given by way of capital allowances and section 23 type relief respectively.
Third level institutions: Buildings used for purpose of third level education or associated sport or leisure activities. Ministerial certification required and expenditure must be incurred by 31st December 2002. Capital allowances available are 15 per cent for 6 years and 10 per cent in year 7.
Rural renewal scheme: Relief for expenditure up to 31 December 2002 on rented residential or industrial/ commercial buildings. Section 23 type relief available for rented residential buildings. Capital allowances available for industrial/ commercial buildings of 50 per cent initial allowance and 4 per cent annual allowance thereafter. Expenditure after 6th April 2001 on industrial/ commercial buildings will not qualify if any part has been grant assisted. Buildings must not be used in certain sectors.
Urban renewal scheme: Expenditure up to 31st December 2002 on commercial / industrial or residential buildings in a total of 43 towns and cities will qualify for relief, except for buildings used in certain specific sectors. Industrial and commercial buildings qualify for 50 per cent initial allowance and 4 per cent allowances thereafter. Section 23 type relief is available on rented residential accommodation.
Interest relief: Interest relief is available on pre 1963 properties acquired after 5th January 2001. The property must consist of at least three units, if the building is converted after acquisition the number of units cannot be less than 50 per cent of the number prior to acquisition and not less than half of the residential units must be available for social housing
Tax based investments
Section 23 relief is only available against rental income. Therefore, this relief is limited to investors with significant amounts of rental income or with cash available to acquire the property.
There is a limit of ?25,000 on non hotel capital allowances which may be offset against non rental income. In many cases therefore, the capital allowances cannot be utilised efficiently unless the investor has significant Irish rental income against which the remaining capital allowances can be utilised.
Capital allowances on hotels are not available for offset against non rental income unless the hotel is situated in the county of Cavan, Donegal, Leitrim, Mayo, Monaghan, Roscommon or Sligo. This type of investment is only useful to a person with significant rental income.
Unitisation provisions restrict the number of investors to thirteen. Together with the ?25,000 limit on capital allowances which may be offset against non rental income each year, this means that the tax efficient qualifying spend is severely restricted. In relation to nursing homes, the most tax efficient amount is ?2,275,000 and if this amount is exceeded, it is necessary for the investors to have rental income in order to efficiently use capital allowances on the expenditure in excess of the tax efficient amount.
As most property investments are priced on the assumption that they are to be relieved at the marginal income tax rate, they are less attractive for companies, whose tax rate is be considerably less than that of individual investors.
Stamp duty of 9 per cent is applicable to investors in second hand residential property. Higher rates also apply to investors in new residential property. This is an additional cost which must be borne by the investor and significantly effects the economic benefit of making such an investment.
Generally, no relief is available for interest on borrowings to acquire rented residential property. This lack of a tax deduction increases the cost of the investment and again significantly affects the economic benefit of making such an investment.
Structuring of property transactions
Several issues must be considered on the sale of undeveloped land. If the land is zoned residential under the county development plan or planning permission for residential development has been granted, then a special 20 per cent rate of income tax or 20 per cent rate of corporation tax applies depending upon whether the land is owned personally or through a company.
If the zoning/planning permission is for industrial/commercial use then the profit is taxed as follows;
• if owned personally, income tax at the person’s marginal rate applies which, given that a large profit is likely is to be earned, is 42 per cent
• if owned through a corporate, the higher rate of corporation tax at 25 per cent (the reducing rate of corporation tax, currently 20 per cent but reducing to 12.5 per cent as from 1st January 2003, does not apply).
When developed property is sold as part of a trade there are several distinctions to note. In this section, developed property means fully developed land i.e. land on which houses, offices, industrial buildings etc. have been built and further material development is not likely.
Residential: An individual selling residential property is considered as having two trades for tax purposes, one the trade of dealing in residential land and the second a trade of construction operations.
The trade of dealing in residential land is subject to taxation at 20 per cent. This applies to both an individual and a corporate. A key issue is how to calculate the turnover from this trade. One method would be to value the site at the date of sale and use this as the consideration from the trade. This value would include all work required prior to foundations being laid.
The balance of the purchase price of the property is the turnover from the construction trade. The costs applicable to this trade are all the costs from laying the foundation to completion of the property. The profit element is subject to 42 per cent income tax.
In the case of a company, the apportionment method does not apply and all of the profit is subject to the reducing rate of corporation tax.
Industrial/commercial: For an individual, the 20 per cent income tax rate does not apply to the site element of the commercial/ industrial development when contained as part of a larger overall trading transaction. Therefore, the 44 per cent income tax rate applies to the whole profit.
In respect of a corporate, the 20 per cent reducing corporation tax rate applies to the full amount of the profits from the sale of the developed property.
Sale of developed property held as an investment
The 20 per cent capital gains tax rate applies both to corporates and individuals.
Trading/non trading
The issue of what constitutes a trade has been the subject of many tax cases. It is outside the purpose of this article to analyze the rules in detail. A very simple yardstick in relation to property is that once a person goes outside the passive sale of property , the danger of being considered as trading exists. An active role in deliberately enhancing the value of the asset before sale with development e.g. by adding services to sites and selling in lots is indicative of a trading purpose.
Structuring of investment property acquisitions
The current thinking is that it is much better to own such properties personally. The reason for this is that there is a double capital gains tax charge in a corporate structure on liquidating the asset into cash. If the investment property is sold there is a 20 per cent capital gains tax liability in the company. To get the cash out of the company, the company must be liquidated. This triggers a further 20 per cent capital gains tax charge as the liquidation of a company is a deemed disposal of the shares by the shareholder. If the investment property had been owned individually and sold, then the gain would be taxed only once at 20 per cent.
However there are three exceptions to the above rule;
• if the property is being used for the purpose of a trade carried on by that person through a company. In that case, if the property is owned by the company, roll over relief can be claimed if the proceeds are invested in other capital assets used for the purposes of the trade. However, it should be borne in mind that rollover relief is only a deferral of the capital gains tax liability,
• for commercial reasons, limited liability may be required to avoid the personal assets of an individual being at risk, and,
• the shares in the company can be sold with a 1 per cent stamp duty applying rather than the 6 per cent rate applying to a land sale and avoiding the double capital gains tax hit. However, a vendor would be dependent upon the willingness of the purchaser to acquire shares. The purchaser’s base cost in the property would be the historic amount originally incurred by the vendor so the purchaser may not be willing to acquire the shares instead of the property without a compensating adjustment.
Property transactions following significant legislative changes are extremely complex and require careful planning. The above text covers the capital gains, income and corporation tax effects of land transactions in a very general way. It does not cover stamp duty, VAT, construction industry withholding tax and the complex anti avoidance rules. Careful planning will avoid costly mistakes and could result in tax savings.
Paul Mee is a senior tax manager at Ernst & Young in Galway. |
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| Article appeared in the May 2001 issue.
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