Should I incorporate my property portfolio?
That is a question we have been asked often in recent months. The answer is – as ever – it depends.
25th September 2020
Laura Wylie See profile
Recent governments have attempted to support home ownership by introducing tax measures targeting private landlords. First, we saw, in 2016, the introduction of the additional 3% Stamp Duty Land Tax (SDLT) charge on the purchase of additional residential properties. Then, in 2017, we saw the phasing in of loan interest restrictions for private landlords.
This second change impacts only individuals owning residential property. Higher rate taxpayers with debt funding on their portfolio will have seen their income tax liabilities increase as a result. This has led to a number of landlords asking whether they should run their properties through a company instead.
For landlords who plan to reinvest their profits, the effective rate of tax is currently 19%. This is significantly lower than the rates of income tax payable by higher rate individual taxpayers which can run to as high as 45%. Incorporating could enable debt to be paid down more quickly or capital to be built up for the next property acquisition.
This ongoing tax benefit diminishes though if the company owners wish to extract the profits, as a second tax charge will occur on the payment of salary or declaration of dividends. However, there is still flexibility of timing over those extractions and there still can be some tax benefits with a highly geared portfolio.
So, for people looking to gear up and build a portfolio of properties, a company structure can work very well.
Aside from the administrative hassle and legal responsibilities which come with operating a limited company, the most significant cons relate to the potential tax charges on incorporation. In particular, the Capital Gains Tax (CGT) and SDLT implications need to be considered carefully. These liabilities are of such significance that they can make incorporation a non-starter for some.
The transfer of properties by an individual to a company they own is a disposal for CGT purposes which takes place at market value. If properties have been held for some time and have benefited from increases in value then this can lead to significant gains on transfer. Current CGT rates on residential property disposals are 18% for basic taxpayers and 28% for those paying at the higher rate.
This gain can be deferred and rolled into the value of the shares if the conditions for incorporation relief can be met. In order to qualify for the relief, the property portfolio must constitute a business. A landlord owning a single property is unlikely to qualify. However, someone with a larger portfolio that is actively managed and who spends upwards of 20 hours a week running the portfolio is more likely to qualify.
Another condition of the relief is that all the assets, excluding cash, must be transferred to the company and consideration given by way of shares. The relief also requires any 3rd party debt to be novated to the company rather than being refinanced and repaid. Mortgage companies tend not to be too good at thinking outside their boxes!
Here again the transfer of properties to a company will be deemed to take place at market value. This can represent a significant cost, albeit there is some relief where six or more properties are transferred. Companies are subject to the additional 3% rate.
Where properties are held in a partnership (which is more than just being jointly owned) then it may be possible to transfer them without crystallising an SDLT charge. This position is not available to properties held in sole ownership. Anti-avoidance provisions prevent the conversion to a partnership ahead of an incorporation.
Residential property is generally exempt from VAT so VAT should not be an issue on the incorporation of a residential property portfolio. However, VAT advice should be sought if there are commercial properties involved.
ATED is an annual tax payable by companies which own UK residential property valued at more than £500,000. Relief is available if property is let to 3rd parties on commercial terms but an annual return still needs to be filed.
It’s always easy to focus on the short term, in this case the taxes payable on incorporation and the annual taxes payable on profits and income. But any decisions should be taken in the context of the long-term objectives of the person and family concerned. If the objectives are to hold properties for the long term then, assuming the upfront tax costs are manageable, then incorporation is likely to be beneficial. But if the capital might be needed in the foreseeable future then incorporating and then having to extract might not be cost effective. This is because there will be a second tax charge on extraction
Taxes on capital assets are always easier to manage if structures are considered carefully at the outset – this reduces the risk that they have to be transferred later on, when the values of those assets may have increased significantly.
For those starting out in property investment, spend time thinking about your long-term objectives so that you can get the right structure in place from the start. For those with an existing portfolio, incorporating a business is complex but, in certain circumstances, it may afford tax advantages.
Either way, professional advice is recommended to ensure you understand the implications and costs before deciding on a course of action. If you would like to discuss this in more detail please get in touch…