Special Tax Reliefs For Property Investment
It is intended that all special tax reliefs for properties will be terminated by 2014. As we go to press the rules for dealing with this are subject to an economic assessment. The proposed rules provided for an immediate termination of the Section 23 reliefs which would have major tax implications for landlords carrying over unused relief. All of our comments below are subject to how the proposed changes will be implemented.
Reducing Tax on Rental Income
The most popular way of reducing rental income tax liabilities has been the very successful Section 23 Relief. This relief allows a double tax deduction for the one cost. The cost of the property can be offset against rents for income tax purposes and when the property is sold the same cost is allowed again as a deduction for Capital Gains Tax purposes.
Self employed individuals or those who run their business through a limited company and who own their own business premises could charge a rent for the property to the business. Then they could purchase a Section 23 Property and use the special tax allowance on the Section 23 Property to reduce/eliminate tax on their rent from their business property.
A. Designated Schemes
There are a number of tax relief schemes available throughout the country for investment in property. These reliefs are contained in different incentive schemes as follows:
Old Schemes
- Urban Renewal Scheme
- Town Renewal Scheme
- Rural Renewal Scheme
- Park & Ride Scheme
- Multistorey car parks
- Living Over the Shop Scheme
- Student Accommodation Scheme
New Scheme
· Shannon Corridor Scheme
While each of the above schemes have their own particular set of rules most of the rules contained within each scheme are similar. The first five schemes above include reliefs for both residential and commercial property. The tax reliefs for the old schemes above have been phased out on a reducing basis up to July 2008. The implications of same are explained in more detail below. While these reliefs have been phased out a new scheme of tax relief for property investment was introduced in 2007 along the Shannon corridor. The intentions of the relief are to encourage investment in tourism related infrastructure. Gambling and licensed premises (excluding restaurants) will not qualify for the relief. The maximum spend on residential property will be 50% of the overall cost of a project.
B. Other Tax Reliefs for Property Investment
Apart from the designated schemes tax relief is also available in respect of the following types of property.
- Refurbished residential property for letting purposes.
- Child care facilities.
- Private hospitals and sports injuries clinics.
- Nursing homes, convalescent facilities and property for the aged.
- Hotels, holiday camps, holiday homes and guest houses.
C. Section 23 Tax Relief
(i) General
In property tax relief terms Section 23 relief has been the most successful relief ever introduced in this country. Throughout the 1980’s and 1990’s it led to a major improvement in the quality of rented accommodation and contributed significantly to the upgrading of previously run down areas of our cities and towns. The relief continues to be available in special designated areas around the country. These areas are in all our major cities and numerous towns throughout the country. Specific sites are designated for this special tax relief. Expenditure incurred during the period ending 31st July 2008 qualifies for the relief. Areas in our capital city where there is significant rejuvenation work being carried out which will qualify for relief include Smithfield, The Coombe, North Inner City, Ballymun and Tallaght.
The amount of development expenditure qualifying for relief is reduced for expenditure incurred during 2007 and for the period from 1st January to the 31st July 2008. For 2007 the amount of expenditure available for tax relief will be 75% of the amount incurred during 2007 and for 2008 will be 50% of the amount incurred in the period to end of July 2008. Qualifying development expenditure incurred up to 31st December 2006 continues to qualify for 100% tax relief. See examples below showing how the reduced relief applies.
There is a lot of confusion about Section 23 relief and the application of the rules for allowing the tax relief. We set out below how the relief operates. The Section 23 relief creates a large rental tax loss in the first year which can be offset against all sources of Irish rental income.
(ii) Operating Rules
- The Section 23 property must be let on an open market basis. It can be let to relatives provided they pay a market rent.
- The first owner must continue to let the property for a period of ten years from the first letting of the property. If the investor is married and dies within this ten year period the Revenue will by concession allow the remaining spouse to step into the shoes of the deceased and will not apply the clawback rule subject to various conditions.
- If the first owner disposes of the property within this ten year period the benefits of the tax relief are taken back by the Revenue. However, the new owner may be entitled to claim the special tax relief. This clawback of relief will not apply where the property is transferred into joint names with a spouse provided it is not being done for tax avoidance reasons. If the property is being transferred to a spouse as part of an approved separation arrangement the clawback will not be applied subject to certain conditions.
- If the second owner lets out the property at arms length and provided he pays the original owner at least the same price for the property as the first owner paid for it then he will be entitled to claim the same amount of Section 23 relief as the first owner.
- The second owner only has to keep the property let for the remainder of the original ten year period which commenced with the first letting by the first owner.
- If the second owner disposes of the property within the original ten year period then the same rules apply and the third owner may be able to claim the Section 23 tax relief.
- In summary the relief attaches to the property during the ten year period from the first letting of the property and may be transferred from owner to owner during this period.
- The tax relief does not have to be fully used up during the first ten years. The owner of the property at the end of the ten year period from the date of the first letting could dispose of the property at that time and retain the benefits of the tax relief.
- The Section 23 tax relief can be claimed in full in the first year if the investor has sufficient rental income from any property in the Republic of Ireland against which the allowance can be offset.
- Alternatively the tax relief can be enjoyed over a long period of years e.g. 5, 10, 15 or 20 years. It all depends on how much rental income the investor has or will have in the years ahead.
- In the first year of claim the Section 23 tax relief on the property is claimed in full. See example below. This creates what is called a rental loss on that property. Rental profits from any other source in the Republic of Ireland can be set against this loss. Any unused balance of this rental loss rolls forward to future tax years until it is fully used up by other rental profits.
- The full price paid for the property does not qualify for tax relief. A formula applies which eliminates the site cost from within the purchase price. The site cost does not qualify for tax relief. The formula works on the following basis:
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- When a new Section 23 property is purchased the builder or his solicitor will issue the necessary certificates certifying site and development costs which will be required in support of the tax claim by the purchaser.
How the rules for claiming the tax relief work in practice can be shown by way of example as follows:
Example 1
| Property Cost |
€500,000 |
|
| Site Cost |
€125,000 |
|
| *Development Costs |
€375,000 |
|
| Special Formula: | 500,000 x |
€375,000 |
|
€125,000 + €375,000 |
||
| Qualifying Tax Cost |
€375,000 |
The 375,000 can be offset against all Irish Rental Income until it has been fully utilised. This could take one year or twenty years depending on the amount of the investor’s rental income.
*Assume all development costs incurred by 31/12/2006
Example 2
Investor has 3 properties one of which is a new Section 23 property which cost €500,000 and has Section 23 allowances of 375,000.
The tax position for the first year is as follows:
|
New Section 23 Property |
Existing Property 1 |
Existing Property 2 |
|
| Gross Rents |
€15,600 |
€15,000 |
€12,500 |
| Less expenses |
(€12,500) |
(€5,000) |
(€3,000) |
| Rental Profit |
€3,100 |
€10,000 |
€9,500 |
| Section 23 Relief |
(€375,000) |
||
| Total Rental Profit (Loss) |
(€371,900) |
||
| Offset Other Profit |
€19,500 |
(€10,000) |
(€9,500) |
| Rental loss for Year |
(€352,400) |
This rental loss of €352,400 rolls forward against future year’s rental profit from all three properties until it is fully used up. The tax saved in year one is €10,396 (€22,600 @ 46%).
Example 3
| a. Facts | Shop Unit let out at Gross Rent (per annum) |
€60,000 |
||
| Tax allowable expenses |
€10,000 |
€50,000 |
||
| Taxable rents | ||||
| TAX/PRSI |
€23,000 |
|||
| Remaining after tax income |
€27,000 |
|||
| b. Proposal | Purchase a Section 23 Property Costing |
€500,000 |
||
| Section 23 allowance |
€375,000 |
|||
| Mortgage |
€400,000 |
|||
| Rent per annum |
€15,000 |
|||
| c. Result | Income: | |||
| Rents – shop |
60,000 |
|||
| Rents Section 23 unit |
€15,000 |
|||
| Total rents |
€75,000 |
|||
| Less | ||||
| Shop Expenses |
€10,000 |
|||
| Mortgage Interest |
€20,000 |
€30,000 |
||
| Taxable rents |
€45,000 |
|||
| LESS Section 23 allowance |
(€375,000) |
|||
| Tax loss against future years |
(€330,000) |
|||
| d. Cash Flow | Rents shop unit |
€60,000 |
||
| Rents Section 23 unit |
€15,000 |
€75,000 |
||
| Expenses – shop unit |
€10,000 |
|||
| Mortgage Interest on Section 23 Property |
€20,000 |
€30,000 |
||
| Remaining after tax income |
€45,000 |
Benefit: The after tax income has been increased by €18,000 and an additional property has been acquired. In addition the owner will enjoy tax free rental income from both properties for another 7 years approx.
(iii) What happens Section 23 Relief after the 31st December 2006
The amount of construction expenditure incurred after this date qualifying for tax relief is reduced. For qualifying expenditure during 2007 the tax relief will be 75% of what it would have been. For expenditure during 2008 but before 31st July 2008 the relief is a rate of 50%. For periods after 31st July 2008 no relief will be allowed. In practice Section 23 properties will be on sale over the next few years. If you are buying a unit that was built during 2006,2007 and 2008 you will need to check the amount of tax relief going with the unit. The reduction in the amount of tax relief can best be appreciated by an example as follows;
New properties built during 2006, 2007 and 2008
Example 1
| Cost of Property | €450,000 |
| Cost of Site | €100,000 |
| Building Costs incurred in 2006 | €200,000 |
| Building Costs incurred in 2007 | €100,000* |
| Total | €300,000 |
| Special Formula | 200,000 + 75,000 = 68.75% 300,000 + 100,000 |
| Cost Price | €450,000 |
| Amount qualifying for tax Relief | 68.75%= €308,250 |
*Note that qualifying building costs for 2007 are reduced to 75%
Example 2
| Cost of Property | €450,000 |
| Cost of Site | €100,000 |
| Building Costs incurred in 2006 | €150,000 |
| Building Costs incurred in 2007 | €100,000* |
| Building Costs incurred in 2008 | €50,000 |
| Special Formula | 150,000 + 75,000 + 25,000 = 62.5% 300,000 + 100,000 |
| Cost Price | €450,000 |
| Amount qualifying for tax Relief | 62.5%= €281,250 |
*Note that for 2007 & 2008 Qualifying building costs are reduced to 75% & 50% respectively
Summary
The above examples illustrate the tax benefits of Section 23 relief. A purchase of one of these properties makes good tax sense for both existing investors and first time investors.
While the operating rules for the tax relief may sound complicated they are in fact relatively straightforward. The passing of the tax relief from one owner to the next within the first 10 years normally ensures a good demand for second hand Section 23 properties by existing investors.
Sophisticated tax schemes are often very complicated and only of benefit to a very few. Section 23 relief with its low entry costs and direct ownership is a relief which can be of great tax benefit to all property investors.
Whether you have none, one or a large number of investment properties and be they residential or commercial or a mix of both, the benefits of a Section 23 property can be used against all properties in the State or in the case of a one off investment ensure tax free rental income over a long number of years.
D. Student Accommodation Relief
Particulars of the Scheme
- The proposed development has to be located within an 8km radius of named 3rd Level Institutes/Colleges.
- There has to be a minimum of 20 bed spaces.
- Each unit has to have a minimum of 3 bed spaces – 55 sq.m.
- Each unit has to have a maximum of 8 bed spaces – 180 sq.m.
- For every 50 bed spaces, 1 bed space has to be provided for students with disabilities.
- Every bed space has to be provided with a data connection.
- A developer has to receive certification from a qualifying 3rd Level Institute as to how many bed spaces they require.
- There is no cap on the rent you can charge.
- Leases can be per bed space or unit.
How the Tax Relief Operates
The rules and regulations governing the scheme are very similar to the Section 23 relief scheme. The qualifying tax cost of the property and the way the tax relief is obtained is calculated in the same manner as for Section 23 relief which has been explained in detail above.
E. Improvements and Refurbishments to Rental Property
There is a special tax relief for certain improvements and refurbishments provided various conditions are satisfied for residential investment property. The property does not need to be a Section 23 type property and can be located anywhere in the country.
This relief applies for qualifying expenditure incurred during the period from the 6 April 2001 to the 31st July 2008. Expenditure incurred during 2007 qualifies for 75% tax relief. In 2008 the rate of tax relief is reduced to 50% for expenditure incurred up to 31st July 2008.
The tax relief applies to refurbishment expenditure which is defined as meaning;
any work of construction, reconstruction, repair or renewal including the provision or improvement of water, sewerage, or heating facilities, carried out in the course of the repair or restoration, or maintenance in the nature of repair or restoration of the building or for the purposes of compliance with the requirements of the Housing (Standards for Rented Houses) Regulations 1993 (S.I. No. 147 of 1993).
Qualifying refurbishment/improvement costs are allowed for tax purposes over a sevenyear period i.e. 15% per annum for the first six years and 10% in the final year. If the property is sold or ceases to be rented out within a tenyear period the tax relief must be paid back to the Revenue. Similar rules as apply for Section 23 properties apply here as regards the application of the 10 year rule.
F. Providing property for childcare facilities
Qualifying Property
Significant tax relief applies to qualifying properties being used for the provision of child care facilities particularly for owner operators of such facilities.
The premises must comply with the rules and regulations of the Childcare Act 1991 and be in use for providing either a preschool service or else combined preschool service with a day care or other service for non preschool children.
Qualifying Expenditure
Expenditure on the construction, extension, conversion and refurbishment of a property being used for providing qualifying services qualifies for the tax relief, which is allowed over 7 tax years initially at a rate of 15% per annum with 10% in the final year.
Amount of Tax Allowance
- Owner Operator 100% relief which can be claimed in full in Year 1 or over a period of years. The annual allowance is 15% per annum.
- Lessor – An initial allowance in year 1 of 100% or 15% per annum for 6 years and 10% in the final year. The allowances are available for offset against all income by way of capital allowances. However, lessors are restricted to a maximum offset of €31,750 per year against nonrental income.
Conditions of Relief
The property must be used throughout a period of 10 years for providing qualifying services only. Any change in the use of the property within this period will mean a withdrawal of the special tax relief already granted. The property must not include any part of the building or structure in use as a dwelling house.
Rental Income Losses
A loss on one property can be offset against the profit on another property. You pay tax on the combined profit or loss of all your Irish investment properties.
If you also own foreign investment properties the same rule applies to all foreign properties, i.e. losses on one can be offset against profits on another. This applies whether or not the properties are in different countries. However, you cannot offset rental losses on foreign properties against rental profits on Irish properties or viceversa.
TAX SAVING TIP
The Revenue will by concession allow the rental losses of one spouse to be offset against the rental profits of another spouse. This is something that has to be claimed when completing your tax return. This concession is unlikely to be allowed where tax avoidance arrangements exist between the spouses regarding their property investments.
Where rental losses cannot be fully set off against other rental profits then you are allowed carry forward the unused losses for offset against rental profits of a later year. The carry forward of such losses while reducing your income for income tax purposes in later years are not allowed when calculating your income for PRSI/Health Levy and Income Levy purposes in later years.
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