How do we deal with VAT and capital gains on our rental property?

My husband and I bought a second house to rent out in 2006 which is worth less now than the purchase price. We owe €80,000 of a mortgage at 1.35 per cent for another seven years.

We registered for VAT at the time so we issue a VAT return for the rental income. Would there be any benefit in paying off the VAT and deregistering?

Would there be any capital gains to be paid if we were to pay off the mortgage and sell at a loss? Is there be any benefit in moving into the house as our principle private ressidence? We are hoping to retire in five years.

Ms EW, email

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Let’s divorce two things here – the capital gains issue and the VAT. The first is reasonably straightforward; the second, I’ll freely admit I know a lot less about.

On capital gains, you have a property that is currently worth less than you paid for it. It is still subject to a mortgage.

There is nothing to prevent you selling the property and taking the hit on the loss. There will be no capital gains tax to pay and you will have a loss that can be offset this year against any gains you may make on the sale of other assets.

If you don’t have enough gains this year to offset that loss, you can carry it forward to offset against future gains, until it is fully offset. That should leave you free of concerns about capital gains tax for a while.

Of course, you could also keep the home. Yes, you can sell your current home. It will be free from capital gains as the principal private residence, ie, your family home, as long as you never rented it out.

You could then move into this former rented property which is currently in negative equity.

If you were later to sell this “new” home, you would have some capital gains tax liability for the 12/13 years during which it was rented. However, if you stay in it until you die, any capital gain would die with you and would not pass to those inheriting the property, if anyone.

So either option is open to you without any immediate tax bill

Depending on your circumstances and other borrowings, there is also the option of continuing to keep this second home as an investment. It is currently under water but – barring another crash – you would expect this loss to narrow over the coming years. In time that could even move to a position where you have made a gain on the investment.

Crystallising a loss without other balancing profitable assets against which you can offset it is never advisable unless you have no other choice.

You have €80,000 outstanding on the mortgage but you are paying only 1.35 per cent on the loan which is a highly competitive rate for a buy-to-let. There are seven years left on the loan. I know you say you are hoping to retire in about five but there should be options either to accelerate payments or pay down the final balance with a lump sum freed from your penson plan (if you have one) on retirement. It’s just something to consider.

Finally we come to the vagaries of VAT law, and here, I freely admit, I am somewhat out of my depth.

What I can say is that if you availed of a tax deduction on the purchase of the property, it appears you might have to make an adjustment under what is called the capital goods scheme. That could see you having to repay some VAT to Revenue.

That aside, whether deregistering now carries any beneift, I’m not sure. I don’t think so but then I’m not sure there would be a significant downside either.

As even the accountancy bodies state this is a complex area, I’m not going to attempt to case study it on the limited details supplied. I do suggest, however, that you consult an accountant on the VAT implications of any sale or revocation of VAT status before taking any action.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or email dcoyle@irishtimes.com. This column is a reader service and is not intended to replace professional advice.