That place in the sun can be so taxing

The rising popularity of owning a holiday home means that the number of Britons likely to buy a second property will double in the next five years, according to new research by Halifax Estate Agents.

About 3.5 million of us already own one, spurred on by a number of factors: ease of travel, the lifestyle away from hectic cities and the opportunities to work from home. While more than a quarter of holiday-home owners have their second properties in the UK, other European countries close to home are also popular, with television programmes such as A Place in the Sun fuelling the dreams.

While many buyers see their purchase as a long-term investment, this can be seriously dented if you do not take the tax situation into account.

Justin Rix, tax specialist at accountancy firm Grant Thornton, says: 'While good weather, availability of low-cost flights and the cost of property are the biggest factors when making the choice of where to buy, local tax implications should also be carefully considered.'

Many overseas taxes mirror our own: taxes on rental income, capital gains on any profit when you sell, and inheritance tax. Whether you buy in Britain or abroad, you are still liable to UK taxes as long as you are a British national and remain a UK resident, though most countries have an arrangement with our Revenue and Customs, so you should not end up being taxed twice. But, as with many tax matters, it is not straightforward.

For instance, as a non-resident owning a home in Portugal, you have to pay tax at 15 per cent on the profit from the rental income. But because in Britain you are taxed at your highest rate - 40 per cent for a higher-rate tax payer - you could end up paying a further 25 per cent. However, you can write off costs such as managing agents' fees and maintenance before paying tax on the income.

'Anything you can do to reduce your UK tax liability brings a real pound-for-pound saving,' says Rix. 'But the converse isn't true. If the tax is higher in the foreign country you can't pay it at the lower UK rate. The double tax-relief provisions mean that if you've already paid tax abroad you can set that off against your UK tax liability. But it's complex so you need to take advice.'

In some countries simply owning a home can lead to a tax liability. France and Spain have a yearly wealth tax on the value of any assets held in their countries. In Spain it starts as low as €167,000 (£116,200) when you have to pay 0.3 per cent of the value each year. The maximum wealth tax is 2.5 per cent on assets valued over €10.5m. In France it is a maximum of 1.8 per cent and starts at €750,000. However, both countries calculate it on the net value, so the mortgage is deducted first.

The most onerous tax is usually capital gains (CGT) on the profit you make when you come to sell your second home. In Britain, you are allowed to make £8,800 before any CGT comes in to play. Each person has his or her own allowance, so couples owning their second home in joint names can make £17,600 without having to pay CGT and you get taper (progressively reducing) relief after three years. You can also deduct the cost of improvements such as putting in a new kitchen or a swimming pool.

You can reduce CGT by choosing your holiday home as your main residence, known as your principal private residence (PPR), as long as it is within two years of buying it. You will get CGT relief for the time you live in it as your main home as well as the gain during the last three years of ownership. As a British resident you will be liable to CGT wherever in the world you make profit, though again you are credited for taxes paid overseas.

Mike Warburton at Grant Thornton says: 'You'd think there would be a disadvantage in electing your holiday home as your main residence because it limits PPR relief on your main house. But the period that you need the election on the second property to run can be very short indeed.'

Even if you keep the profit offshore it will not escape the attention of the British taxman. 'Information is routinely exchanged between Revenue authorities in different countries,' Rix says.

For those planning to retire abroad it is best to take advice first, both in the country where you plan to settle and in the UK.

You will need to write wills in the country where you have assets and familiarise yourself with the inheritance tax regime. In most of Europe there are rules about which family members must inherit all or some of your estate when you die.