It has always been something of a dream. You buy a holiday cottage in a British beauty spot such as the Lake District and, in addition, achieve tax savings through a multitude of different routes.
Firstly, the purchase could often be funded by capital gains tax savings if you sold a business asset to fund the venture. Secondly, any losses you made during the relatively short periods you were obliged to let the property to others could be used to reduce you Income Tax from other sources. Losses were frequent for tax purposes because you could usually claim part at least of any mortgage interest payments as well as more direct expenditure on the property. If you did make a profit, the Income was treated as earned income enabling additional pension contributions to be made.
When the time did come to sell, the capital gains tax was at worst much reduced and, if you were unfortunate enough to die whilst still owning the property, your estate usually managed to avoid any Inheritance Tax liability on the value of the property.
It is fair to say that the key tax attractions for many property owners have been either the Income Tax loss relief rules or, increasingly, the perceived Inheritance Tax advantages.
The taxman eventually even had to concede that these advantages should be extended to properties anywhere in the EU plus Iceland, Norway and Liechtenstein.
This was probably too much for the authorities who feared a massive loss of tax through the use of overseas properties and it was announced that the special reliefs were going to stop. The present Government reviewed that decision and announced that, whilst the special status of holiday lets would be retained, it would nevertheless be restricted.
These restrictions have come in a number of ways. Firstly, from April 2012 there is to be a significant (50%) increase in the number of days that the property has to be let out on a commercial basis or available to let. If these limits are not met the Income Tax and Capital Gains Tax advantages are not available. This is likely in due course to be a routine check for the taxman when making enquiries and so good records are vital.
Secondly the ability to set losses against tax paid on other income has been withdrawn. This is major blow to many property owners.
The potential Inheritance Tax savings were dealt with under quite separate rules and here the legislation has not changed. The reality of the position is, however, a little different. For a number of years the way in which HMRC has interpreted the law has been increasingly restrictive making claims for tax relief more and more difficult.
Because it is a question of interpretation, we are in the hands of the courts and the good news is that the latest battle was won by the taxpayer. Unfortunately, the bad news is that the decision was widely thought to be a surprise and the war is likely to be won by HMRC. Buying holiday lets on the back of expected Inheritance Tax savings is now for optimists only.
Partner and Head of Tax
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