OWNERS OF HOLIDAY RENTAL PROPERTIES FACE CAPITAL GAINS TAX BLOW
Two news items relating to the Alojamento Local (AL) registration system for those property owners involved in short-term lettings to tourists further have reduced the chances of anyone registering without being forced to.
Owners who have their AL licence and who later remove their property from the scheme, for whatever reason, then are liable to pay capital gains tax, whether they are selling their property or not.
The current percentage of properties covered by AL registration is a parlous 20% of the estimated total private rental market – a figure the government does not dispute while taking little action to ensure or force compliance.
To collapse the illegal rental market would hit tourism revenue - tourism being the economic sector showing the highest growth and the one that is allowing Portugal to adopt more of a swagger along the corridors of Brussels. The government needs tourists and needs them to spend money and to date has not acted to close the illegal rental market despite claims to the contrary.
For many property owners, the thought of being charged capital gains tax on top of the annoyance and cost of AL compliance is the final straw but those already registered are locked into a CGT charge should they withdraw from the rental market, so have decided to bear the costs of compliance, Social Security payments et al, whether they actually rent out their property or not.
This ludicrous situation, which everyone consider an absurd fiscal mess apart from the governement, deters those applying for an AL licence to legitimise their property rental income while forcing owners wishing to return their property to private use to carry on.
“This issue of capital gains is one of the biggest obstacles to the legalisation of local accommodation,” said Eduardo Miranda, president of the Association of Local Accommodation in Portugal (ALEP), adding that some owners “keep the registration and do not cancel the activity,” just to avoid triggering a CGT charge which does not qualify for the usual 50% reduction, but is levied at 95% of the gain.
The little-known way around this is to register at Finanças under the category F tax regime where at flat rate 28% is charged but this may not be cost effective for many. A degree of specialist financial knowledge seems to be necessary in a market sector that should have clear rules and simple benefits for those who comply.
On the plus side, the recent amendments to the Alojamento Local registration system, that made it compulsory to gain the approval of other property owners if the property comes under ‘condominium rules’, are likely to be suspended until after the October 1st local elections - or may not be enacted at all.
The government has admitted that it did not bother to talk to everyone that could be affected by the law change and now is well aware that the proposed changes will not help its support at council level.
The revelation on June 2nd that Hortense Martins, a Socialist Party MP with shares in a hotel group, played a key role in developing AL amendments that disadvantage owners of properties under condominium rules, feasibly advantaging the hotel sector, does nothing to present a government that is on top of the Alojamento Local system. (Click HERE)
The Secretary of State for Tourism, Ana Mendes Godinho, is riding on a wave of anyway increasing tourist numbers but has failed to respond to the private rental market’s needs in which the avarice of the tax department has been allowed the upper hand.
The AL system remains an embarrassing muddle with 80% of property ownwers deciding to ignore the rules while pocketing the untaxed cash.
ALOJAMENTO LOCAL: CGT AND ASSET ALLOCATION
As described in my blog post CGT in Portugal, the sale of a property may cause CGT liabilities when, in simple terms, the sales price (valor de realização) is higher than the purchase price (valor de aquisição).
Owners of AL properties have been caught by surprise when they heard about potential CGT liabilities associated to the business activity of renting out their property to holidaymakers (CAE 55201 and 55204).
Most of the owners who obtained an Alojamento Local license for their property, registered as self employed entrepreneurs (Empresário em Nome Individual) in category B, at the Portuguese tax office (AT), not knowing that the property would be allocated to the business activity based on its current market value, which has to be indicated by the owner on their Portuguese IRS income tax return under Annex B.
CGT 1: Allocation Value and Purchase Price (Category G)
The allocation may generate a CGT liability caused by the difference between the purchase price and the market value of the property at the time it was allocated to the business activity (allocation value). This CGT is due only at a later stage, i.e. when the owner decides to close the business activity (deallocation of the property from the business activity) or when they sell it. Residents receive a 50% exemption before the gain is added to their income and taxed at marginal rates whilst non-residents pay a flat tax of 28%. As it seems, this CGT may soon be suspended.
CGT 2: Allocation and Deallocation Values (Category B)
The deallocation of the property may generate another CGT liability, caused by the difference between the market value of the property when it was allocated (allocation value) and the market value of the property when it was deallocated (deallocation value). If the owner falls into the simplified tax regime, 95% of the gain, which in this case is a mere increase of the property’s value, will be added to the global annual income and taxed at marginal rates (residents) or assessed at 25% (non-residents). For owners who declare their rental income in category B, but do not fall in the simplified regime (standard accounting – contabilidade organizada), tax is calculated on the net profit (profit before tax), i.e. between income and allowable expenses.
Let’s illustrate the above through an example:
A property is bought for 200,000€ in 2015 and allocated to the business activity (simplified regime) in 2016 based on its market value (210,000€). In 2017, the owner decides to deallocate the property from the business activity as they no longer intend to rent it out to holidaymakers. Let’s assume the market value is then 220,000.
Putting aside qualifying expenses and the inflation adjustment in order to simplify the example, the numbers line up as follows:
Example 1: Resident
Taxable capital gain 1 (category G): (210,000€ – 200,000€) *0,5 = 5,000€
Taxable capital gain 2 (category B): (220,000€ – 210,000€) * 0,95 = 9,500€
Total gain to be added to the owner’s annual income is 14,500€, which will be taxed at marginal rates.
Example 2: Non-Resident
Capital Gains Tax 1 (category G): (210,000€ – 200,000€) * 0,28 = 2,800€
Capital Gains Tax 2 (category B): ((220,000€ – 210,000€)) * 0,95) * 0,25 = 2,375€
Total CGT: 5,175€
Please note that these two figures (example 1 and 2) cannot be compared as the gain obtained by the resident was not yet taxed, whilst the total amount in Example 2 is already the tax which the non-resident owner will pay.
These examples demonstrate that CGT for residents is higher in category B than in category G as they do not benefit from the 50% exemption before the gain is added to their income and taxed at marginal rates, whilst residents pay more CGT in category G than in category B. Residents should therefore deallocate the property from the business activity prior to a sale.
From what I was able to find out, many tax payers declared a low market value, sometimes only the fiscal value of the property, not knowing that this may cause an increase of the CGT on a future sale or deallocation of the property from the business activity.
The allocation/market value is therefore of crucial importance when it comes to CGT liabilities within the AL business activity. In order to guarantee a low or non existing CGT in category B, the allocation and deallocation values should be similar or the same. Since by law it is the taxpayer who determines the market value, it is important that it is also realistic as it may be challenged by the AT.