When buying a property to renovate and earn a profit you need to consider whether HMRC will treat/tax you as a property developer or a property investor. When it comes to tax, it is important to know whether the ‘profit’ element is a capital gain or a trading profit. This will determine how it is taxed and at what rate.
Trading or investment
The tax consequences will depend on whether the property is an investment or whether there is a trade. The question is whether you are a property developer or a property investor.
Much of it comes down to your intention when you bought the property. If the aim was to buy the property, do it up and then let it out, the property will count as an investment property. However, if the intention is to buy, renovate and sell at a profit, HMRC may regard you as trading. However, an intention to sell at a profit at some point in the future does not automatically mean you are trading. Also plans change, and a property purchased as a long-term investment might be sold after a relatively short period of time as a result of a change in personal circumstances.
Badges of trade
The concept of the ‘badges of trade’ has been developed from case law and provides a series of tests that which can be used to determine whether an activity is a trade or an investment.
The ‘badges of trade’ tests, whilst not conclusive, are used by HMRC to help determine whether an activity is a proper economic / business activity or merely a money-making side line to a hobby. Careful consideration needs to be given when deciding if a hobby has become a taxable activity. The nine badges of trade are as follows
- Profit-seeking motive
- The number of transactions
- The nature of the asset
- Existence of similar trading transactions or interests
- Changes to the asset
- The way the sale was carried out
- The source of finance
- Interval of time between purchase and sale
- Method of acquisition
Where there is a trade, the property will only be held for as long as it takes to do up and sell. A property developer is likely to develop more than one property, either simultaneously or in succession. Where there is a trade, the property will be sold to realise a profit; for an investment property, the sale may be triggered by other factors.
Case study 1
Chioma inherits some money and invests in a property, which he plans to do up and rent out. He completes the renovations and rents the property for six years before selling it to enable him to buy a larger family home.
The property was purchased as an investment and would be regarded as an investment property. The gain on sale would be liable to capital gains tax.
Case study 2
Joshua sees a run-down property on the market and spots the opportunity to make a profit. He buys the property, spends six months renovating it, selling once complete, making a profit of £40,000. He invests the proceeds in another property to renovate and sell.
Mark would be treated as trading. His aim is to sell the properties at a profit. Consequently, he would be liable to income tax rather than capital gains tax on the profit.
*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.