Property investors need to budget for various expenses, including legal fees, maintenance costs and unexpected outlays. These can quickly pile up. Fortunately, there are steps you can take to reduce the amount of tax you pay to HMRC.
Capital Gains Tax (CGT) is payable on the profit made from an investment or transaction. CGT on property gains is charged at a higher rate of 28% compared to the 20% currently levied on all other assets (for higher rate tax payers).
But, with the use of the Enterprise Investment Scheme (EIS), qualifying investors can mitigate their CGT liability.
The most high-profile benefits of EIS include:
- 30% income tax relief on EIS-eligible investments
- CGT payments on property can be deferred (indefinitely) when reinvested into EIS shares
- There is no CGT to pay on gains from EIS investments themselves
Here’s an example to illustrate how this might work in practice:
Imagine you invest in a residential property deal and make £100,000. Under current tax laws, you may have to pay CGT on this at a rate of 28% (or £28,000).
However, if you were to take this £100,000 profit and invest it in one or more EIS deals then the CGT bill is deferred until whenever you sell these shares. That means for that year, or however long you hold those EIS shares, you won’t have to pay CGT on the initial £100,000 profit from the property investment.
In addition, there is no CGT to pay on the gains from this EIS investment (if the investment is held for at least three years). So if you were to make a profit of £50,000 on that investment you would get to take home all of it.
Plus, you’ll be able to get 30% income tax relief on this £100,000 (therefore reducing your income tax liability that year by £30,000).
As we mentioned, the CGT rate of 28% only applies to residential property gains and for all other assets higher rate tax payers are currently charged a CGT rate of 20%. When the EIS shares are disposed, they are then subjected to the regular rate of 20% and therefore a reduction of 8%.
So, in this example, the CGT liability – once the EIS shares are sold – is brought down to £20,000 (or 20%).
What’s more, the 30% income tax relief could come in handy when paying this CGT liability. For instance, if your income tax liability was £100,000 as well then you would receive a £30,000 cheque from HMRC that would more than cover the CGT bill.
There are generous allowances and reliefs on offer from HMRC but there are some important factors to keep in mind when considering an EIS investment especially if you’re looking to benefit from tax mitigation strategies.
Firstly, to qualify for income tax relief you can’t be connected to the ‘investee’ company and this covers employment or having a significant financial interest in it. HMRC are vigilant on this point so conditions apply from two years before the issuance of EIS shares and up to three years after the investment is made.
You can invest up to £1,000,000 in any number of EIS-eligible companies in a given tax year and you must hold these shares for a minimum of three years to benefit from the tax benefits. This measure was introduced by HMRC to persuade investors to focus on the type of young, growth company that EIS was originally launched, 25 years ago, to help support.
You must be a UK taxpayer and you can not carry-forward your EIS tax relief (however, you can carry this relief back to the previous tax year). And, most importantly, when it comes to buying EIS shares these must be a brand-new issue by the company and not already existing on the market.
Everyone’s financial matters are different, and the use of EIS for tax mitigation may not be suitable for you. But it might help reduce your capital gains tax liability significantly and is, at the very least, worth exploring.
To learn more about EIS and how it can benefit investors, visit our EIS Guide.
To qualify for EIS/Investors' Relief, investors must be UK resident for tax purposes (or have UK tax liabilities) and subscribe cash for new shares in qualifying companies. Tax treatment is dependent on individual circumstances and may be subject to change. This content is written in general terms and you are strongly recommended to seek specific advice before making any investment. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this content. It is also important to realise that investing in small companies always carries risks, including the loss of capital, illiquidity (the inability to sell assets quickly or without substantial loss in value), lack of dividends and share dilution. Investments should still be made as part of a diversified portfolio.