Due to the tax changes affecting landlords, property owners have been asking if they should incorporate their rental properties. There are a number of taxes to consider and as usual the answer is; it depends. This means each case should really be looked at on its merits. However, as a generalisation, we are finding small landlords with one or two properties have not found it worthwhile. It is likely to be more suitable for sizable portfolios with significant borrowing.
A husband and wife property partnership held £2.5m of property in a mixed residential portfolio, mortgaged and generating £200,000 of gross rents per annum. With mortgage interest of £65,000 pa and other costs, the net profit was around £110,000 pa. With the effect of the changes in how tax relief is given the profit would be pushed to £175,000 pa, into the additional (45%) rate band, and then only allow a 20% tax credit on the mortgage interest, costing £19,000 more in tax each year.
Ordinarily in such a transfer, capital gains tax would be payable on the disposal of property. However, because of the size of the portfolio, it was considered a business, and incorporated using S162 incorporation relief in order to avoid crystallising inherent capital gains within the properties. Instead, the gain is rolled over into the shares of the new company, as long as the consideration is by way of share capital.
Stamp duty is also usually payable in the transfer of a property but in this case it wasn’t chargeable as the business partners were the same before and after the incorporation. To be eligible for this it is important that it is a partnership here and not just joint ownership.
Bank or lender consent is required before transferring any properties, but in this case beneficial interest was transferred to the company by a declaration of trust and legal title remained with the individual as trustee. This is yet to be tested by HMRC but is becoming a recognised solution to the lending problem.
The result? The property business is incorporated within a company without crystallisation of capital gains tax or stamp duties, and a tax saving of at least £13,750 pa!
The decision to incorporate should not be undertaken lightly, or without specific advice on the case in question, but when it works it can save significant amounts of tax. For more information, or to discuss any property issues, please contact us.