Personally owned rental property portfolios may not be as lucrative as they once were.
In recent years, we have seen the withdrawal of tax relief for loan interest on borrowings taken out to acquire rental property, as well as increasing rates of income tax and decreasing tax band thresholds.
A question we are often asked is “would it be better to own these properties through a limited company?”.
That’s not always an easy question to answer. Every case needs to be considered on its own merits and circumstances.
It’s true that owning a property portfolio through a limited company can offer significant benefits, such as reducing the rate of tax that is applied to rental profits and side-stepping the restriction on tax relief for mortgage interest that applies to properties held personally.
Let’s consider what’s involved if you decide to transfer your rental property to a limited company.
Firstly, you have to recognise that this is a legal process. In essence, you have to ‘sell’ your properties to your company. This will involve paying various costs, including taxes and conveyancer fees, but also potential loan redemption charges etc.
- Capital Gains Tax will be payable on the increase in value of the property being transferred from the cost originally paid and its market value at the day of transfer. The amount of Capital Gains Tax will vary between 18% and 28% depending on your personal tax position.
- Stamp Duty Land Tax, often referred to as SDLT, is payable on transfer. This is a standard charge based on your property’s worth. But in addition, because the investment property isn’t your main residence, you will also pay a further 3% surcharge as it falls under the ‘second home’ category.
- Conveyancing and solicitor fees. As if you were selling to another individual, standard procedures, including the need for a solicitor or conveyancer, will apply.
- Early redemption charges and increased mortgage costs. Some lenders charge a repayment fee if you’ve only just started paying your mortgage off. This is typically between 1% and 5%.
For some landlords, these costs make moving to a limited company prohibitive. For others, the long-term tax savings far outweigh these upfront fees.
Incorporation Relief
The Capital Gains Tax charge mentioned above can be avoided if the transferred property portfolio is a business for tax purposes.
The difference between a property business and simply having property investments largely depends on the number of properties and the time it takes to manage the portfolio.
Case law has shown that property letting may consist of sufficient let properties and engagement by the owner to constitute a business, and the ‘Ramsay case’ is the main piece of case law in this respect.
Here, Mrs Ramsay devoted 20 hours a week to managing the portfolio and had no other occupation during this period. The court decided that the level of activity was sufficient to deem her work in respect of the portfolio as being beyond the mere passive receipt of income and therefore satisfied the business test for Capital Gains Tax relief.
On this basis, HMRC assumes that a business exists when a person spends 20 hours a week or more working on the property portfolio. This requires the portfolio to consist of more than a handful of properties. If your portfolio consists of a few properties, you may have difficulty convincing HMRC that you spend 20 hours a week working on the portfolio. They will judge a case on its facts, and they need to stack up.
If the portfolio is a business, it should be possible to transfer the entire business to a limited company in exchange for shares in that company without triggering Capital Gains Tax. Instead, the shares you receive in the company will have a reduced base cost for tax purposes, meaning Capital Gains Tax may instead be due on any future disposal of those shares. However, the company is deemed to have acquired the properties at their value at the date of incorporation, meaning the company will be taxable on any future growth in the value of the properties but not the growth before incorporation.
SDLT and Partnership Incorporation
While incorporation relief can avoid Capital Gains Tax on moving properties to a company, SDLT will still be due unless you are not just incorporating a business but a partnership.
A partnership is a business that is carried out by two or more people, and unlike a business carried out by one person, it does not trigger SDLT when incorporated into a company in exchange for shares.
In addition to demonstrating that a business exists, the partners of a partnership must show that they are in business together. This means they must each separately have sufficient scale to their property activities rather than holding investments, such as each partner spending at least 20 hours a week managing the portfolio. They must also have a partnership agreement, a partnership bank account and have registered the partnership with HMRC.
Anti-avoidance provisions are in place to stop partnerships from being formed to benefit from SDLT relief on incorporation. It is a sensible approach to ensure a partnership exists for at least three years before considering incorporation, something which must be demonstrable and once more will be judged on its facts.
Incorporation and Inheritance Tax
Companies are often protected from Inheritance Tax (IHT) by means of a tax relief called Business Property Relief or BPR. This may lead people to assume that incorporating a property portfolio will qualify for BPR and avoid IHT.
Unfortunately, BPR is typically available to the owners of trading companies and it does not apply to those who have incorporated a property business into a company.
If you incorporate a property business into a company, the value of those properties remains in your estate for IHT purposes, as the shares you own will reflect the value of the assets held by the company.
Bear in mind that had you not incorporated the property business, the value of those rental properties would nevertheless form part of your IHT estate on death.
All is not entirely lost. Incorporation has some potential IHT benefits, for example, the use of tailored types of shares may offer long-term IHT protection of future growth in the value of the properties. Or borrowing on the property can sometimes create a loan account that can reduce exposure to IHT. Once again, such considerations will pivot on circumstances and prevailing views at the time.
If you wish to discuss this further, contact our property expert, David Herd, on david.herd@championgroup.co.uk or call 0161 703 2500.
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