An unfortunate side effect of successful property investment is the close interest that the taxman will take in you. But there are ways to mitigate, and sometimes do away with entirely, an unwanted tax burden. It is a complicated area - but I will try to keep it simple. So, all you have to do now is sit up at the back and pay attention.

When you sell a property that has been rented out, you are likely to have Capital Gains Tax (CGT) to pay. However, with planning and knowledge, you can reduce and perhaps even eliminate CGT liability.

Assuming that the value of the property has gone up, capital gain is the difference between the buying and selling prices, less the costs of buying and selling. If you sold or gifted the property to a relative other than your spouse or to a trust at below market value, market value must be used. If you inherited the property, the market value is that used for probate.

The capital gain figure needs to be adjusted to take account of inflation over the time the property was owned. For properties owned from March 1982 to April 6, 1998, you use something called indexation relief. (Properties owned before 1982 also qualify for relief but indexation only runs from March 1982).

From April 6, 1998, you use taper relief. If you owned a property before April 6, 1998, use indexation relief for the period up to then and taper relief after that.

Suppose you bought a property in May 1984 for £100,000 including transaction costs and sold in April 1998 for £220,000, after selling costs. Over that period, inflation had been 82.8 per cent. You can therefore reduce your £120,000 gain by 82.8 per cent of the original £100,000 price, ie £82,800, to reflect the effect of inflation over time.

If you had extended the property, you would also have to work out the effect of inflation on the cost of the extension from the time you extended until you sold.

If you ever lived in the property, you get extra exemptions. Everyone is entitled to Principal Private Residence (PPR) relief on their main residence. What is less well known is that this relief can be extended over three years after you have moved out of your main residence and the property is then let. So, suppose you bought a property in year 0 and sold it in year 7 and you lived in it from year 0 to year 4 as your main residence but rented it thereafter, the first four years wouldn’t count as it was your main residence but the last three years wouldn’t count either. Thus, there would be no CGT to pay.

Now, suppose you rented out the property for longer - say up to year 10. In this case, there may still be no CGT to pay. The reason is that another relief called Private Letting Relief (PLR) comes into play. PLR is the lowest of:

• 1. The amount of gain already exempted under PPR.
• 2. The gain as a consequence of the letting period.
• 3. £40,000 per owner. In this example the four years you lived in the property as your main residence are exempt plus another three years out of the ten - ie, seven out of ten years of the indexed gain is exempt. This leaves only three years as chargeable.

If the indexed gain was £90,000, the amount chargeable would be 3/10 of £90,000 = £27,000.

The amount exempted under PPR would be 7/10 of £90,000 = £63,000.

As the lowest figure of £27,000, £63,000 and £40,000 is £27,000, this amount is also automatically exempted as a result of PLR.

The chargeable gain before letting relief is £27,000 (i.e. 3/10 x £90,000) less lettings relief of £27,000 leaves zero gain. As you can see, the Revenue is quite generous to landlords who let out their former homes.

In April 1998, indexation relief was replaced by taper relief. It does not kick in until the property has been owned for three years and rises by five per cent each year up to ten years when it reaches 40 per cent. Any property owned before March 17, 1998, and still held on April 6, 1998, qualifies for an additional bonus year.

If you bought in September 1990 and sold on September 6, 2004, you would work out the indexed gain for the period up to April 1998 first.

As taper relief only applies from April 6, 1998, in this case it will be six years, plus one additional year because the property was owned before March 17, 1998 - ie seven years in total. For seven years, the taper relief is 25 per cent.

If your gain after indexation relief, PPR and PLR was, say, £60,000, you would have an additional relief of 25 per cent of £60,000, ie £15,000, leaving a potential capital gain before any exemption of £45,000.

The annual CGT exemption is currently £8,500. So, if you had a potential capital gain of £45,000, you will have to pay tax on £36,500. You must offset capital losses for the current year against any chargeable gains before taper relief is applied. With a bit of luck, and if you have used all the relief and exemptions available, you may have no capital gains tax liability at all. Well done!

CGT is payable at 10 per cent, 20 per cent or 40 per cent. For a basic rate taxpayer paying 22 per cent on their employment income, any capital gain is taxable at 20 per cent until they reach the higher rate threshold when it increases to 40 per cent.

Some people set up limited companies to run their rental business, the attraction being the lower rate of corporation tax compared to personal income tax. However, a company doesn’t get PPR relief, taper relief or an annual exemption from capital gains. Also, there may be tax to pay when taking profits out of the company. So, take advice on whether it’s worth doing.

For most people, the best way to reduce or eliminate IHT is for spouses to divide their assets equally and arrange their wills so that each person’s assets only pass to the surviving spouse on death above the unused nil rate band. This ensures the nil rate of IHT (£275,000) is not wasted. If you own your properties as tenants in common, you can draw up wills so that half goes to your children on death.

Couples with over £550,000 assets and who think they have surplus wealth to give away, can make a lifetime transfer as a potentially exempt transfer (PET) to their children directly or into an accumulation and maintenance trust (if the kids are under 25) or a life interest trust. If they want more control, they can put up to £275,000 each into a discretionary trust. In both cases, after seven years it drops out of the estate.

Tax expert Helen Demuth at Smith & Williamson likes discretionary trusts because gains on assets settled can be held over, but warns that the taxation of them is complicated. Rental income and capital gains are taxed at 40 per cent. However, if income distributions are made to beneficiaries paying less than 40 per cent tax, they can reclaim the difference straight away.

There is also a special IHT charge of up to six per cent if the trust’s value exceeds the nil rate band. This charge is made on the tenth anniversary and every ten years thereafter.

David Lawrenson is the author of Successful Property Letting - How to Make Money in Buy-to- Let, published by Elliot Right Way Books, £9.99