Investing in commercial property may seem intimidating at first, but with the right information and advice, it can offer lucrative opportunities. Unlike residential properties, commercial properties, including student and hotel accommodations, have distinct tax implications.
Understanding these differences is crucial for maximising the advantages they offer to investors. This comprehensive guide highlights key tax considerations that should be taken into account when venturing into commercial property investments.
Stamp Duty Land Tax
Just like residential properties, the purchase of commercial property attracts Stamp Duty Land Tax (SDLT), which must be paid within 14 days of completing the sale. There are no additional rates for subsequent purchases or if you already own residential property.
Commercial property SDLT rates
The SDLT rates for commercial property are as follows:
| Property Value | Stamp Duty Land Tax Rate |
| Up to £150,000 | Zero |
| £150,001 - £250,000 | 2% |
| Any portion above £250,000 | 5% |
When it comes to income derived from letting commercial property, taxation applies. Valid revenue expenses, including letting agents' fees and loan interest, can be deducted. The specific tax rates depend on the structure of the purchase and whether it is held by an individual, a trust, or a company.
VAT
When it comes to the sale of commercial property, VAT regulations play a significant role. While commercial property sales are generally exempt from VAT, property owners have the option to charge VAT at the standard rate of 20%. This decision would extend the VAT charge to all associated supplies, including rent.
New commercial properties, those less than three years old, are subject to VAT at the standard rate. However, student accommodation, including halls of residence, is exempt from VAT, provided the necessary certification requirements are met.
In the case of hotel accommodation, VAT is typically applicable unless a long lease is granted for another party to operate it as a hotel business, or the property has opted to tax. Investors looking to purchase hotel rooms or suites for investment purposes should expect this arrangement to be in place.
Given the complexity of VAT matters, seeking professional advice is highly recommended when navigating commercial property purchases.
The Tax Benefits of Commercial Property Investment
When it comes to commercial property investment, choosing the right legal structure is a significant decision for property investors. There are four main ways to invest:
- Personal Investment: Investing in your own name.
- Company Investment: Investing through a company.
- Indirect Investment: Investing via an ISA (Individual Savings Account).
- Pension Investment: Investing through a self-invested personal pension plan (SIPP).
Each option carries different tax implications that can have a significant impact. Let's briefly examine the tax considerations associated with each option.
1. Holding property personally
Most investors prefer to buy commercial property directly in their own name, as it offers certain advantages. One significant benefit is the potential eligibility for special capital gains tax treatment when selling the property.
This treatment, known as "business asset taper relief," allows for three-quarters of profits to be tax-free after just two years. It serves as an excellent capital gains tax shelter, with a maximum tax rate of 10% and potentially even lower rates thanks to the annual capital gains tax exemption.
However, there is a limitation to qualify for business taper relief. If the property is let to a quoted (stock exchange listed) company like Vodafone, you won't be eligible. While it may seem appealing to have a reliable tenant like a large brand, this choice would result in the less favourable non-business asset taper relief. This relief only exempts 5% of profits after three years and 40% after a decade.
When it comes to rental income, there are no concessions. Income tax rates of 22% or 40% apply, depending on whether you're a basic-rate or higher-rate taxpayer. Therefore, alternative investment strategies should be considered if protecting rental income is a priority.
While minimising taxes is important, it's equally crucial to focus on generating profitable returns. Finding the right balance between tax optimisation and income generation is key for successful commercial property investment.
2. Holding property in a limited company
Using companies as a legal structure for property investment has gained popularity due to lower corporation tax rates compared to personal tax rates. If you choose to invest through a company, your tax implications may differ from those of a personal investor.
With rental income, you can benefit from lower tax rates, even as low as 0%. For instance, if you earn £15,000 in rental profits, the first £10,000 will be tax-free, and the remaining £5,000 will be taxed at 23.75%, resulting in an effective tax rate of just 8%.
However, it's important to consider that companies don't qualify for the generous business taper relief available to direct investors when selling property. Instead, companies are eligible for an indexation allowance, protecting against tax on inflationary profits, typically around 3% per year.
If you sell shares in the company rather than the property itself, you may personally qualify for taper relief, albeit at reduced non-business taper rates.
Investing through an ISA or self-invested personal pension plan (SIPP) offers a potential escape from income tax, capital gains tax, and corporation tax.
3. Using an ISA
Currently, you can invest up to £7,000 per tax year in an ISA and enjoy tax-free profits on your investments, exempt from both income tax and capital gains tax.
However, it's important to note that ISAs typically do not allow investments in property. There are a few exceptions to this rule.
4. Using a Self-invested Personal Pension
To have more investment choices and flexibility, consider purchasing commercial property through a self-invested personal pension (SIPP) instead of ISAs.
Investing through a SIPP offers several advantages. Firstly, you can benefit from tax-free rental income and capital gains, as no income tax or capital gains tax is payable on your SIPP investments.
Additionally, you receive tax relief on any contributions made to your pension account. This means you can effectively purchase property at a discounted rate of 40%.
Business owners particularly find commercial property SIPPs appealing, using them to acquire premises for their companies. The company would then pay rent to the SIPP, allowing it to claim the expense as a tax deduction, while the SIPP itself would be exempt from tax on the rental income received.
Capital Gains Tax
When selling a commercial property personally, you will be subject to Capital Gains Tax (CGT) on the increase in property value. For properties held in a limited company, Corporation Tax applies to annual company profits. CGT rates for commercial property are lower than residential rates, with 10% for basic rate taxpayers (18% for residential) and 20% for higher rate taxpayers (28% for residential).
You only pay tax on gains exceeding the tax-free allowance, currently set at £12,300 (Annual Exempt Amount). Additionally, certain expenses can be deducted, including Stamp Duty Land Tax and allowable purchase and disposal fees.
Capital Allowances
Capital Allowance Relief can be claimed on moveable plant and machinery purchases for commercial properties.
However, it is often overlooked that Capital Allowances can also be claimed for fixtures within a commercial property.
These fixtures include cranes, fire alarms, security systems, heating and air conditioning systems, lifts, escalators, moving walkways, sanitary and kitchen equipment, and sprinkler systems.
Until 31 December 2021, there is a temporary provision for 100% tax relief under the Annual Investment Allowance rules for the first £1 million of capital expenditure (which will then decrease to £200,000).
When purchasing a property, it is possible to allocate a percentage of the purchase price to these items, potentially up to 25% of the original purchase and refurbishment price in some cases. This allocation can be used to offset future profits, resulting in several years of not declaring taxable profit. To benefit from this, it is crucial to document it as part of the purchase agreement.
Super Deduction Tax Relief
The Budget 2021 introduced a new 130% Super-deduction First Year Allowance (FYA) that provides an additional one-third reduction in tax for expenditure on new main pool plant and machinery. Initially available only for trading companies, an amendment to the Finance Bill now allows landlords and investors to claim this Super deduction tax relief for qualifying plant and machinery.
Furthermore, the 50% Special Rate First Year Allowance (SR allowance) offers eight times more tax relief compared to the previous 6% writing down allowance (WDA) for various other plant and machinery assets.
These enhanced reliefs present an attractive opportunity for landlords, as there is no upper limit to their application.
Make The Most of Your Commercial Property Investments with Tax Natives
Ready to optimise your UK tax obligations when investing in or selling commercial property?
Look no further than Tax Natives. Our team of experts is here to guide you through the intricacies and help you explore the best strategies for maximising your tax benefits. Whether it's deciding on the right ownership structure or navigating VAT considerations, our professionals have the knowledge and experience to assist you.
Contact Tax Natives today to explore your options and ensure you make the most of your commercial property transactions.