You may think flats above shops sound like a dismal proposition, but investing in the rooms above your local kebab shop could be one of the most tax-efficient ways to get on to the buy-to-let bandwagon.

Despite the Chancellor closing the door on tax relief of up to 40 per cent for people wanting to buy bricks and mortar through pensions last year, similar relief on residential property investment is still available for converting unused space above shops into flats.

The generous relief is available for money spent turning commercial space such as offices or storage rooms above shops into apartments under a tax concession that has been only rarely used since it was granted by the Treasury in 2001 in a move to promote the development of affordable housing in town and city centres.
So far only a handful of property developers and buy-to-let investors have taken advantage of the tax break but a new fund is aiming to allow a wider public to benefit from the relief.

The main attraction of the scheme is that a higher-rate taxpayer who pays £100,000 into the plan receives £40,000 back in tax relief once his or her original stake has been spent on conversion into residential units. After this money is spent he then owns a share of the improved property. The actual purchase of the property is funded by loans from banks, with the amount borrowed typically double the amount of cash raised by investors. Rent from the properties is supposed to cover the interest on these loans, provided the flats are rented 90 per cent of the time, and investors benefit from the increase in value of the property both as a result of the conversion to residential units and any upward trend in property prices in the area.

Tax relief is only available if the property is held for seven years from the date the units become habitable, making the investment a 10-year plan. As the tax relief is only granted for funds spent on development, it usually takes three years for it to be recouped in full by the investor. After 10 years the properties are sold and any increase in equity is shared between investors. This will attract capital gains tax, although with taper relief this will usually be payable at the rate of 24 per cent.

However, investors should not let tax relief dictate where they put their money. You have to consider whether the investment stacks up on its own. If you are planning to invest in this sort of property anyway, then this is a tax-efficient way of doing it, but you need to make sure that you are comfortable with the management team before you invest. This type of investment is geared through borrowing, meaning that if the property falls in value, then the reduction of the investor's original stake will be amplified, although this can also be said of any of the 750,000 buy-to-let investments that rely on mortgages.

Compared to investing in a single buy-to-let, this is less risky because your money is spread across more than one property, and you have the cushion of the tax relief in the event that there is a downturn.

There are other government incentives for landlords to create new housing units provided you are prepared to ask around. Some local authorities will pay grants to shop owners to convert rooms above their premises into residential flats, although they must then be rented to social-sector tenants for up to five years.

Your home may be repossessed if you do not keep up repayments on your mortgage.
Article date: 10.06