Headline prices can make overseas property seem affordable, but wherever you buy, taxes can add up to quite an expensive extra commitment. Be sure to factor them into your calculations from the start, writes Jeremy Davies.

Once you've come across the holiday home of your dreams, complete with little olive grove, sea view and friendly neighbours, the last thing likely to cross your mind is tax. Sadly, though, tax, in its many and varied forms, is as much a part of buying a property overseas as it is in the UK.

The amount you pay will vary from country to country, as will the type of tax payable. In France, for example, you must pay stamp duty at 4.8% of the declared value when you buy a property more than five years old. Newer properties are exempt but instead you must pay French VAT at 19.6%.

In Spain you will be liable for property transfer tax at 6%, or VAT of 7% plus 0.5% stamp duty if the property is brand new. A local capital gains tax, plus valia, is levied on sellers but is by convention paid by buyers. In most cases the amount due is fairly low, but if the property has not been sold for a long time and the value has shot up, it can produce a nasty shock and you may wish to negotiate an according drop in price.

Italian property purchase taxes generally add up to 10% of the property's taxable value, although for some formerly agricultural properties the rate may be 18%. You must pay VAT at 10% on most new builds.

In all three countries, these taxes are charged on the value of the property as declared in the deed of sale, which has traditionally borne little resemblance to the price actually paid. The penalties for tax dodging in this way are severe and include compulsory state purchase at the declared value, plus fines. Under-declaration is now less common in France, but the Spanish and Italian authorities may still turn a blind eye.

Wherever you are buying you will be liable for the local equivalent to council tax. France has the taxe fonciere, a land tax payable whether or not there is anyone living in the property (although this is waived for two years if you do major renovation work on it) and the taxe d'habitation. This is payable by whoever is resident on the property on January 1, but again this may be waived if doing the place up renders it temporarily uninhabitable.

Spain has an equivalent residential property tax called impuesto sobre bienes immuebles; the Italian version is imposta comunale immobili. In all cases these taxes combined are generally cheaper than UK council tax, but bear in mind you must also pay separate taxes for rubbish collection and water rates.

Working out the longer-term tax implications of your purchase can be a complex business, and it is important to take advice before you buy. The Institute of Chartered Accountants of England and Wales runs an online searchable database of firms that is worth consulting.

If you're buying a second home you will be liable for income tax in the country where it is located on rental profits. If you remain a UK resident for tax purposes (your local tax office should be able to provide you with relevant Inland Revenue leaflets to advise on this) you will also be liable for UK income tax - although double tax agreements mean what you've paid abroad will be discounted from any further liability here.

In France, there are several ways of handling letting income for tax purposes. The easiest is to deduct 72% from your annual turnover as expenses and be taxed on the remaining 28%. Spain charges a flat rate of 25% tax on gross rental income and will tax you as if you rent your property out even if you don't. You will be charged 25% on an assumed notional income of 2% of the property's valor catastral (the official value also used as the basis for the declared value in the purchase deed), or 1% if the valor has been adjusted since 1994. The system in Italy is similar, although tax rates vary between 23% and 45% according to the level of income.

Remember too that if you sell the property at a later stage, you will - assuming it is a second property - be liable to capital gains tax. In France this is charged at 33% of the net gain for non-residents, falling by 5% every year after the first two years. In Spain the rate is 35% for non-residents; there is a complex system of allowances which only start to reduce your liability significantly after five years. In both cases, the rates are lower for tax residents. In Italy capital gains are taxed as income within the first five years of ownership.

Italy abolished inheritance tax in 2001, making it a relatively simple retirement destination in terms of estate planning. But passing on property can still be a complex business in France and Spain; in both there are strict rules about who you can leave it to, and if you are unmarried your partner could be left paying punitive tax rates. Especially if you and/or your partner have children from more than one relationship, you'll need a good tax adviser to help you pick your way through the minefield.

Making two wills - one in the UK and one where the property is - can help you get around many of the problems. It is also a good idea to be careful about how you specify your marital finances on the purchase deed. Putting the property in your children's names and retaining a life interest for yourself may be worth considering, although gift tax may apply. There has been a trend of buying second homes through offshore companies to avoid inheritance and other taxes, but this route may cost you dear as the UK taxman can levy income tax on the 'benefit in kind' of you being able to occupy the property rent-free.

 Careful planning could ease the headache of tax, but very little will make it go away. As ever, though, it's best to tackle the issue head on from the start rather than put it at the bottom of your list of things to think about. Or, find yourself a good tax adviser capable of taking the job on for you. Leaving you to tend your olive grove at will.  

Monday August 2, 2004