There is significant tax relief waiting to be unlocked from commercial property, but there are still plenty of misconceptions and misunderstandings about the rules.
One common misconception we encounter concerns Capital Gains Tax (CGT) and Capital Allowances.
When a commercial property is sold at a profit, the profit is subject to CGT. The profit or gain is calculated by deducting the original cost of the property, plus any capital additions (for example, refurbishments, renovations, extensions or additional land acquisitions) from the proceeds of sale. This deduction is known as the ‘Base Cost’.
We frequently see examples of accountants believing their clients will end up paying significantly more CGT than they owe because of an understanding that a claim for Capital Allowances must be deducted from the Base Cost before the CGT is calculated.
The fact is, you do not need to do this, so it can be one of the costliest mistakes an accountant can make for their client.
Example: If someone bought a petrol station for £500K ($685K) and later extended it for $274K before selling the entire property for £1M ($1.36M), the profit on which CGT is due is £1M – (£500K + £200K) = £300K ($410K).
The Base Cost, in this example, is £700K ($959K).
If Capital Allowances available on the property acquisition and subsequent extension are calculated to be £175,000 ($240,000), some accountants will then deduct this to reduce the Base Cost to £525,000 ($719,000). This has a dramatic impact on the CGT owed by artificially increasing the profit.
Capital Allowances do not reduce the Base Cost of the property if sold at a profit. This statement is supported by the tax legislation, Section 41 (1) TCGA 1992, which states:
“Section 39 shall not require the exclusion from the sums allowable as a deduction in the computation of the gain of any expenditure as being expenditure in respect of which a capital allowance or renewals allowance is made.”
The legislation makes clear that any expenditure eligible for Capital Allowances is not deducted when calculating the gain generated by the sale of the asset.
Exceptions to the Rule
There are two main exceptions to this rule. Structural Building Allowances (SBAs) are a relatively new type of Capital Allowances tax relief, which are now also available on the construction costs incurred on a commercial property. SBAs do have a negative impact on the Base Cost. This renders SBAs essentially a cash flow exercise, as any benefit is effectively paid back when the property is sold. This isn’t an issue, however, if the owner has no intention of selling.
Reassuringly, any Plant & Machinery Allowances (PMAs) on the embedded plant, which must be identified before claiming SBAs, have no negative repercussions.
The second exception occurs when a property is sold at a loss. When this is the case, Capital Allowances reduce the allowable loss for CGT calculations. The Base Cost is reduced by the amount of Capital Allowances retained which, in turn, reduces the allowable loss, but not to the point that it can create a gain.
The loss can only be offset against future Capital Gains, so retaining Capital Allowances may not be the most tax-efficient option, particularly for a company, as it is likely the loss will be wasted in any event. It may be more beneficial to dispose of the Capital Allowances to the buyer and perhaps negotiate a larger premium instead.