JP writes: My wife and I have recently set up a property development business focused on renovating and extending old houses. We are operating effectively as a partnership as we will offset much of the personal tax by investing in venture capital trusts.

We have completed and sold one property this financial year, the sale of our second property is due to complete this month, and we have just started work on our third property. All of the costs for the third property will be incurred and paid in the 2011-12 tax year. However, the sale proceeds will be received in the 2012-13 tax year.

When we submit our tax returns for 2011-12, can we include all of the costs we have incurred and paid on the third property against the profits earned on the first two properties, or do we have to hold over the costs for the third property until the tax year in which we sell it?

The recognition of the purchase and development costs should be made at the same time as that of the sales proceeds for accounting and tax purposes, writes Jon Sutcliffe, partner at Kingston Smith LLP.

This means you won’t be able to offset the cost on property 3 against the profit on property 2 where they are sold in different tax years.

The sale proceeds should be recognised when they are unconditional, usually at the point of exchange or on completion. Until then, all costs should be carried forward in your accounts as work in progress (WIP). This can include any interest on financing that development. At the end of your accounts period, you should reduce your WIP to its market value where you do not anticipate making a profit on the development.

You should be careful if there is a chance that a development project may be retained and let. If this happens, the property moves from WIP to investments, and you are taxed on the development profit, despite not selling the property. If you plan to develop the property to let it, you should treat it as such from the outset. You will eventually have a capital gain (rather than development profit) when the property is sold. You should also seek VAT advice.