For business owners, recent tax changes have thrown up an interesting loophole in property investment. With some clever tricks and careful research, investors are finding ways to keep their tax bill low and revenues high. Long seen as a route to profit and financial freedom for the middle classes, buy-to-let property investment has been hit hard by recent changes in the tax regime. Anyone involved in residential property investment in 2016 needs a fresh approach if they want to navigate costs and maintain revenue. We explore the tricks.
What's changed?
On 1 April 2016, the Conservative government introduced a surcharge of three percentage points on stamp duty on any second homes or residential 'buy-to-let' investments.
This came on top of the shock announcement in 2015 which removed the option for landlords to cite mortgage expenses as a tax expense. The move means landlords will essentially be paying tax on turnover rather than profit. It is set to be phased in from 2017 and in full swing by 2020.
Commercial property buyers, on the other hand, saw positive changes come in in the March 2016 Budget. Instead of the previous flat rate, commercial property buyers are now charged a different rate for each band of the property's value.
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1) These rates of Stamp Duty Land Tax for commercial buildings are calculated on the property’s purchase price. For anything up to £150,000, there is zero rate. For the portion between £150,001 and £250,000 a two per cent tax is charged, while the portion over £250,000 will be taxed at five per cent.
2) For residential properties, the rates for Stamp Duty Land Tax are slightly different. They break down as follows: properties up to a purchase value of £125,000 are exempt, while any portion from £125,001 to £250,000 will be taxed at two per cent, from £250,001 to £925,000 at five per cent, from £925,001 to £1.5 million at 10 per cent, and any portion above £1.5 million at 12 per cent.
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So while residential buy-to-let investors have been hit hard, commercial property buyers are seeing the opposite. In fact if Treasury estimates prove accurate, around 90 per cent of commercial property buyers will be looking at lower stamp duty bills.
Where's the loophole?
The loophole for residential purchases arises from the fact that semi-commercial property or mixed-use property falls under the commercial property stamp duty regulations. This means that a business premises with a residential property attached – for example a shop or office with a flat above – will fall under the lower commercial property stamp duty tax.
The cost savings are significant. A £300,000 second home or buy-to-let residential investment would incur a stamp duty of £14,000. On a mixed-use property of the same value, a buyer would pay just £4,000.
It is however much harder to obtain an interest-only mortgage for a commercial property and interest rates on commercial mortgages will usually be higher than for residential mortgages. This means anyone who is in a position to move will face reduced competition and the sale price will often be less than that paid for an equivalent property or space classed as residential.
Shaun Church, a director of mortgage broker Private Finance, told The Telegraph investors are already taking advantage of this approach: “Because it's cheaper to buy commercial property, a buyer could look at getting planning permission to convert a building from commercial back to residential.
“The square foot value is more attractive if it's residential, so you could make a profit on sale.”
Who is taking advantage?
For an out-and-out property investor, the risk involved in the planning process could well be an issue. However, for a business buyer, the risk becomes an opportunity due to the potential to diversify income streams.
As Mr Church noted: “You've got two different types of property, so it's an easy way for someone to diversify and reduce their risk.”
As a result, business owners are among the first to take advantage of these changes; people who were already on the lookout for a commercial premises for their company seizing the opportunity to improve their gains.
By bringing a residential angle into the purchase, the opportunity opens up to rent to staff members, or to rent on the private market to generate a second income stream to supplement that of the core business. By buying a mixed-use premises, there is also the potential to rent to a residential tenant and a commercial tenant, generating a steady, passive dual-income stream that accordingly spreads risk.
Exit strategies
Buying a mixed-use premises saves the buyer money at the outset when looking at the residential aspect of the investment. The saving arises from both stamp duty discount and from the reduced market price that commercial and mixed use properties often command in pricier residential areas. And lower capital outlay directly contributes to higher returns.
But it is down the track where the biggest win lies with this kind of investment.
As a business buyer you will understand the importance of having a clearly defined exit strategy from the start. With a mixed use purchase there are various scenarios: You could be buying into a vacant commercial space with the intention of using the premises for your own enterprise with the residential quarters used by yourselves or rented out. You could be buying into a vacant commercial space and intend to apply immediately to switch use to residential. That route can then branch into an immediate sale of the whole site following development at market residential price; or a ‘develop, hold and rent’ scenario at a higher yield.
If the commercial space is tenanted, you may be looking ahead to renew the lease upon expiry; terminate the lease upon expiry, refurb and re-let at higher yield; or terminate the lease upon expiry having already applied for change of use to residential.
The recent tax changes have created a very useful window of opportunity that can be tapped into by a seasoned entrepreneurial business buyer to purchase capital assets under market rate and leverage them into future profits. Good luck.
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