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.