Balance through tax

It surprises many people to learn that, over the long term, residential property prices have traditionally given very modest capital returns. Returns are generally in line with inflation, albeit with the occasional boom and bust in between.

Many might be too young (or perhaps forgetful) to remember the late 80s boom and subsequent crash. Instead, perceptions of property are based on the spectacular boom that arrived between 1997 and 2007, and because there was no real crash (merely a stalling of the market) there were fairly few horror stories of repossession to dampen people's enthusiasm.

Of course one advantage is that like shares, property can provide a 'dividend'; rental income. However in real value terms, this is an indirect benefit since it normally leaves the 'portfolio' to meet mortgage borrowings.

This is where the real benefit of property lies; banks and building societies will lend you money to buy, either to live in or to let out. It is exactly this gearing (borrowing to invest) that has given people the really spectacular investment returns from property.

As always though, potential for gain goes hand in hand with potential for loss. People often forget that as much as gearing can amplify your returns, it can also magnify your losses.

Property taxes

Unfortunately, there are also some tax drawbacks that are particular to property.

The income from individual residential properties generally can't be sheltered in the same tax efficient manner as the dividends or interest from your savings or investment. Although the interest element of mortgage payments is currently tax-relieved, there is some pressure to get rid of the tax advantage.

Unlike stocks or shares, you cannot place a buy-to-let property into an ISA, investment bond or a pension fund. Because of this, owning rental property (especially if it is not mortgaged) can lead to significant income tax issues.

The capital gains from property can, like shares, be offset against your annual capital gains tax allowance of £11,100. However you can't carry forward those allowances to use all in one go when you eventually sell, and of course it's difficult to realise a chunk of a property each year along the way.

For that reason, many buy to let investors will benefit from just one allowance in the year they sell, rather than the year-on-year tax allowances that other investors enjoy. Investment properties can quite easily become pregnant with gain over time.

Inheritance tax

Perhaps the final drawback comes from inheritance tax (IHT). With many people having built up property portfolios since the late 90s, some are now starting to have IHT concerns.

One such person recently contacted us. They were financially secure with a portfolio of half a dozen houses, including their home and a holiday property. They needed the rental income to help fund their retirement (they had some pensions but most of their money had been invested in their properties).

We quickly identified that, on their deaths, inheritance tax would effectively mean their children would give one of their properties straight to the taxman. When we explained it in these terms, it came as something of a shock to our new client.

Fortunately he accepted that the time had come to give up some of his portfolio in favour of share based inheritance tax plans. This allows him to retain an income from some of his capital, while starting to shelter it under trust for his children. There is a saving straightaway, but the real advantage comes in seven years, when he may have sidestepped all of the IHT bill.

Of course there is a great deal to be said for an investment that you can actually see and touch; share investing can seem abstract and therefore less comfortable. However the phrase 'past performance is no guide to future performance' applies just as much to the property market, so it's important not to let historic returns rule your thinking.

It is equally as important, of course, to make sure tax considerations won't erode your investment success. 

Scott Gallacher is a director at Rowley Turton

He writes the regular IFA comment in Private Client Adviser