Should I Incorporate my Residential Property Business?
Private landlords came under attack in 2015. They were subjected to significant tax changes, including:
A. From 1 April 2016 a stamp duty land tax (SDLT) supplement of 3% will be levied on purchases of second homes and buy-to-let properties. For example, a landlord buying a property for £100,000 will have £3,000 of SDLT to pay when he buys after April 2016, whereas if he bought the same property before 1 April 2016 he would pay no SDLT;
B. From 6 April 2017, the amount of income tax relief on mortgage interest relating to residential property will be gradually reduced for higher rate taxpayers so that from April 2020 a landlord's tax liability will be reduced by only 20% of the interest. Currently, the highest earning landlords reduce their income tax by £45 for every £100 of mortgage interest paid;
C. The 10% wear and tear allowance for fully furnished properties will be abolished from 6 April 2016. Instead, tax relief will only be given for actual expenditure on replacement furniture, white goods and certain other items; and
D. If a landlord sells a property at a capital gain, from 2019 he will be required to pay his capital gains tax (CGT) within 30 days of the disposal of the residential property. Currently individual landlords have up to 21 months (depending when in the year they sell) after the sale of a property to pay CGT.
The restriction of mortgage interest relief (mentioned in point B above) will hurt the most for many landlords. The government says the change is introduced "to make the tax system fairer" as "landlords with higher incomes…receive the most generous tax treatment". The government also mentioned a Bank of England report which said the increase of buy-to-let mortgages might pose a threat to financial stability.
The restriction of mortgage interest relief only affects individual landlords. It does not affect companies with buy-to-lets. Many landlords are considering incorporating their business (namely, transferring it to a company). It is not a decision that should be taken lightly. Many landlords have operated quite happily for decades as a sole trader in their own name or as partners.
The factors that a landlord should consider before incorporating include:
1. Property investment companies can be useful for estate planning. Shares can easily be transferred to the next generation(s) or held in trust. Different classes of shares can be used so dividends can be paid to whoever needs them at the time.
2. There can be inheritance tax (IHT) advantages as minority shareholdings can be discounted in calculating an IHT liability.
3. Holding property in companies can be better than holding personally as there can be a lower rate of capital gains tax (CGT) when a property is sold. Also, companies can still claim indexation allowance, which allows the cost of a property to be increased in calculating CGT by the same proportion as the increase in the retail prices index over the period the company has owned the property. We are currently in a low inflation era, but this can be valuable, particularly as property is typically held for a long time by many landlords.
4. Many landlords are deterred from incorporating as they hold property that is standing at a substantial capital gain. It might be possible to avoid that gain on incorporation by the use of a special relief that is available when businesses (including buy-to-let and other property businesses) incorporate.
5. Avoiding the restriction on mortgage interest relief: see point B above.
6. Careful thought is needed regarding stamp duty land tax (SDLT) if an existing property held by individual(s) is to be transferred to a company. It might be that this can be mitigated with appropriate planning. Even if there is SDLT to pay on the incorporation the savings on, for example, mortgage interest relief might make the incorporation worthwhile. Landlords need also to be aware of the rules on companies buying a valuable (more than £500,000) residence as SDLT can be as much as 15% for those properties.
7. Historically, many landlords have been put off incorporation because of a potential double hit of tax: one at the company level on rents and another at shareholder level when cash is extracted from the company. However, the recent changes might make incorporation a more attractive structure for property holding
8. Landlords need to consider carefully their intention. If the intention is largely to roll up the rents then that might be able to be done more efficiently in a company as it will be done at corporation tax rates rather than income tax rates.
9. Many landlords rely on the rents from their properties to fund their lifestyle. Some number-crunching is needed to compare the net of tax position using a company to staying unincorporated. The new rules on the taxation of dividends effective from 6 April 2016 will need to be taken into account.
If you are considering incorporating a property business please contact Nasim Sharf (01482 337336, firstname.lastname@example.org) or any member of the Rollits' corporate team. Rollits LLP has a proven track record of working with existing advisers to ensure all accounting, tax and legal considerations are covered in business incorporations and in advising family-owned businesses.
This article is an overview and simplification of complex rules. It should not be relied upon without specific, detailed advice.
This article is for general guidance only. It provides useful information in a concise form. Action should not be taken without obtaining specific legal advice.