Andy White, Senior Partner at London accountants CBW, explains why residential property investors should be popping corks as the window of opportunity opens.
This article was written for and first published in Property Investor News.
We live in politically turbulent times. Ignoring shifts in the geopolitical landscape, the emergence of China and India as economic powers and the political upheaval in the Middle East, here at home we have rarely witnessed such change in so short a time. The Lib Dems have been all but wiped out as a Parliamentary force, the Labour Party is non-existent as the opposition and a right-wing single-issue party, regularly grabs an unprecedented share of the popular vote.
As if that weren’t enough, the country has now voted to exit the EU, an institution which has regulated so much of our lives for over 40 years. It’s hardly surprising that, amidst all this turmoil, asset prices have been volatile.
The FTSE 100 has bounced around in an extraordinary manner. Initially spooked by the possibility of Brexit, which saw the futures market plummet, it then rebounded strongly as investors appreciated the power of foreign earnings of its constituent companies. Property prices have risen strongly or crashed depending on where you are and the relevant price bracket. So why is all this instability good news?
It’s always difficult to time the market and while price falls generally presage a buying opportunity, such a strategy often requires a foresight and courage uncharacteristic of many. There is, however, a tax angle to this, which presents significant opportunities.
Some facts about tax
It’s worth highlighting that until an asset is disposed of and a gain or loss crystallised no tax event exists and no tax consequences arise. In the case of property, for example, the economic reality is very different. Property values can increase sharply and, assuming constant yields, this is reflected in higher rents and an improved financial position. Yet no tax will be payable in respect of the enhanced value of the asset until sale.
Capital Gains Tax is for the most part a tax that concentrates economic activity into a single moment in time. For this reason, it was the custom for many years for investors to “bed-and-breakfast” their holdings (particularly, shares). This practice involved selling shares and immediately buying them back, very often, to crystallise a loss. Leaving aside dealing costs, this ensured that a tax loss could be recognised while no economic change actually took place. The same taxpayer owned the same shares before and after the transaction.
Similar tax opportunities arise in times of price volatility. It’s well known that one of the cornerstones of estate planning is to give assets away. Inheritance Tax is based on the value of an estate on death so the more one gives away during one’s lifetime, the lower the value of the estate and the tax bill on death. Frequently, the only assets suitable for making such a gift are properties or other assets, such as company shares, which may have risen in value since they were first acquired.
For Capital Gains Tax purposes, it’s a disposal which triggers the tax. This is normally a sale, but could also be a gift in which circumstances HMRC deems the gift to have been made at market value. This is what is known as a dry tax charge: tax becomes payable even though the payer has received no benefit from the transaction. Indeed he or she will be worse off as a result of the transaction (having gifted the asset) yet still has to pay tax.
There are some reliefs in the tax code, which are available to reduce or eliminate this tax, but they are difficult to access and are only available in certain restricted circumstances. However, if prices have fallen and there is no longer any gain in the asset, this could be an ideal opportunity to make the gift.
Another situation where price falls should not be overlooked is where the executors of a deceased estate dispose of a property. In most cases, Inheritance Tax is charged on the agreed value of assets at the date of death and transactions post-death are ignored. However, where property is sold within three or in some cases four years of death, a claim can be made to substitute the sale value. Clearly if prices have fallen this is likely to be of benefit.
There are countless situations where a drop in values can be exploited for tax as well as commercial reasons. The truth of the matter is that asset price volatility presents opportunities as well as threats in all manner of areas and, as ever, tax should not be overlooked.
Andy White’s specialist area is advising clients on their strategic tax affairs. He combines deep technical knowledge and creativity to deliver real taxation solutions that advance clients’ business and personal interests. To find out how CBW can help you formulate an effective residential property strategy, contact Andy or any member of the property team on: (0)20 7309 3917 or email firstname.lastname@example.org