Insights

Property investment has been declining in popularity in recent years, as incremental government changes to tax legislation have slowly eroded the benefits of residential buy to let investments. One of the most troublesome aspects of these changes has been the gradual removal of mortgage interest tax relief. In the 2018/19 tax year, 50% of finance costs will receive tax relief at a taxpayer’s marginal rate, and 50% will receive tax relief at the basic rate of tax only.

The higher rate of relief will continue to taper away; by the 2019/20 tax year, only 25% of finance costs will attract tax relief at the taxpayer’s marginal rate, with 75% receiving a basic rate tax reduction; by 2020/21, all finance costs incurred will receive only basic rate tax relief. This is clearly not good news for landlords paying the higher or additional rates of tax.

Investors with highly geared rental property portfolios are those who are are struggling the most with these changes, and for some it has resulted in a rush to sell and exit the buy-to-let property market completely. According to research conducted by Capital Economics for the National Landlords Association, this is true of 20 per cent of landlords, who are planning to sell up over the next year because of the tax changes.

Some landlords are taking the loss of tax relief on the chin, and some are trying to mitigate the impact of this loss of relief by transferring ownership of their properties to a limited company.

Pros and cons of transferring property to a company

Under company ownership, residential landlords can continue to claim tax relief on their mortgage interest, just as they could on any other commercial loan. Because the rate of tax payable by a company is currently only 19%, the rate of relief is also only 19%, however rental income is also only taxable at 19%. There can be an additional benefit, depending on the incorporation route taken, in that it is possible to obtain an uplift in the base cost of the property for capital gains tax purposes, so that on a future sale of the property the company will pay tax only on the sale proceeds which exceed the market value of the property on the date it is transferred to the company.

This appears attractive, but it is not as straightforward as it sounds and there are a number of hurdles to be overcome.

Firstly, it means changing the property mortgages from your personal name into the company’s name, which means complications with your lender and possibly a higher interest rate; secondly, the process involves a change of ownership, because it requires the property to be ‘sold’ by the original owner and ‘purchased’ by the new (company) owner. Even if no money changes hands, this can give rise to tax liabilities based on the open market value of the properties because the transfer is between connected parties.

The taxes involved are capital gains tax at the rate of up to 28% payable by the seller and stamp duty land tax (SDLT) payable by the new company owner.

Capital gains tax can be avoided if you are able to demonstrate  that you are running the residential properties as a business and can therefore claim ‘roll over relief’.

Will you qualify for roll over relief?

This enables you to ‘roll over’ the capital gains arising on your properties based on their market value when you transfer them to a company.

The relief is only available if you can demonstrate to HMRC that you are running your property portfolio as a business. Qualifying for roll over relief will depend on how much time you personally spend managing your rental properties. According to HMRC, provided you have evidence to demonstrate that you are personally working in your property lettings business for at least 20 hours per week, you should qualify for relief.

SDLT can be avoided if you can demonstrate that the property business is run in partnership.

Will you qualify for relief from SDLT?

Relief is available where a partnership property business is transferred into a limited company. HMRC takes the view that a partnership is unlikely to exist if you are one of a number of joint owners who merely let property. However if you let property jointly and provide significant additional services in return for payment it is more likely they will accept that a partnership exists. Much depends on the level of business activity involved, and the existence of a partnership depends on a degree of organisation being in place, such as you might expect to find in any commercial business.

Both of the above issues require specialist advice.

Potentially a good long-term investment

Entering into a transaction like this has many financial implications and needs to be considered carefully.

You will become a shareholder in the company and the properties themselves will no longer be assets you personally own.

Rental profits will be assessable to corporation tax in the company at the rate (currently) of 19%, but if you wish to take money out of the company this will be by way of salary or dividend, which will suffer additional tax. If you wish to leave the money within the company to reinvest in property growth, the rate of tax is much more attractive.

In situations where you are looking to hold on to the properties and reinvest profits in growth within the company, company ownership may be a good option. This gives flexibility to take funds from the company in the future, possibly as a pension, when your income tax rates are potentially lower.

Partnerships are the first step

If you are considering incorporating your property business with minimum tax impact, the first step is to demonstrate the existence of your partnership business with accounts and with facts demonstrating the level of involvement of the partners. You will also want to start reviewing your mortgages, consolidating these where possible and discussing the possibility of incorporation with your mortgage lender.

If this is all too complicated and you consider you are unlikely to qualify for the tax reliefs,  you might consider continuing with your existing portfolio as it stands but purchasing any new properties through a limited company.

Getting to the point where you can make an informed decision often means undertaking some tax planning well in advance of the final transaction.

If you have a residential property rental portfolio and are wondering what to do to mitigate your future tax bills, contact Lesley Stalker for some impartial advice. We cannot advise you on mortgage options, but we can help you to understand the short and long-term tax implications of incorporation and whether it would be right for your circumstances.

partners@rjp.co.uk