There can be money to be made buying a property in a dilapidated state, renovating it, and selling it for a profit. However, 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 something of a checklist which can be used to determine whether an activity is a trade or an investment. The six badges of trade are as follows:
- The subject matter of the transaction.
- The length of the period of ownership.
- The frequency or number of similar transactions.
- Reasons for the sale.
- Motive when acquiring the asset.
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
Paul inherits some money and invests in a property, which he plans to do up and rent out. He completes the renovations and rents out 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
Mark 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.
Partner note: HMRC’s Business Income Manual BIM20200ff.