The tax considerations for incorporating your property portfolio

Incorporating your property portfolio, transferring ownership of your properties from your personal name to a limited company, can generate some important tax advantages for landlords. However, taking this step may not be right for everyone so it is important to understand the tax implications.

Ian Pring, Chartered Tax Adviser and Partner at Westcotts, explores the benefits of incorporating your property portfolio and the key tax considerations.

Why should landlords consider incorporating their property portfolio?

Incorporating your property portfolio means transferring ownership of your properties from your personal name to a limited company. It can have several tax advantages which means landlords are increasingly opting to take this step.

Section 24 means that individual residential property landlords can no longer offset their mortgage interest against their rental profits. Instead, they receive only a basic rate income tax credit. This has increased tax liabilities for landlords, particularly those with high levels of mortgage borrowings, and encouraged many landlords to incorporate their existing portfolios.

The recent confirmation from the Chancellor that the main rate of corporation tax for a company of 25% will be capped for the life of this Parliament, whilst the top rate of income tax for an individual landlord is 45%, is also driving many towards incorporation.

What are the main tax issues to consider when incorporating?

When looking at incorporation of an existing property portfolio, the two main tax issues to consider are capital gains tax (‘CGT’) and stamp duty land tax (‘SDLT’).  As the transfer is to a ‘connected person’, being the company in the landlord’s ownership, the landlord is treated as selling the properties to the company at their open market values for CGT purposes and the company as buying the properties at these same values for SDLT purposes.

How will Capital Gains Tax (CGT) impact the incorporation of a property portfolio?

Where chargeable capital gains arise in the landlord’s hands, comparing current values to deductible purchase and improvement costs, this can create a ‘dry’ CGT charge of up to 24%. This will be payable by the landlord within 60 days of incorporation.

Where the landlord is running a rental business, rather than simply holding a small number of investment properties, and where the rental business is transferred to the company in exchange for an issue of shares, incorporation relief can automatically apply. This will avoid CGT on incorporation and roll over the gains arising into the tax base cost of the shares. However, CGT liabilities can still arise where the landlord’s mortgage debt exceeds the CGT base cost of the property portfolio.

One helpful point to note is that in the company’s hands the rental properties tax base costs will be their market value on incorporation. Incorporation relief can therefore be useful for landlords with large inherent gains looking to sell off parts of their portfolio and reinvest the proceeds without the impact of immediate CGT liabilities.

How will Stamp Duty Land Tax (SDLT) impact the incorporation of a property portfolio?

The company will be liable for SDLT, payable within 14 days of property transfer. Where less than 6 dwellings are transferred, the company will pay SDLT at the +5% higher rate surcharge residential rate. Where 6 or more dwellings are transferred on incorporation the company will pay SDLT at non-residential rates. Note that where any single dwellings in the rental portfolio are worth more than £500k, relief from the flat 17% higher rate needs to be claimed via the SDLT return.

Where a rental business is run as a partnership, special provisions operate on incorporation which can mean that no SDLT is payable by the company in appropriate circumstances. Both incorporation relief and the existence of a partnership rely on there being a rental business rather than the passive holding of investment property.

Are there any tax planning arrangements to overcome these issues?

A couple of tax planning arrangements have been aggressively marketed over recent years seeking to overcome these issues on incorporation. These arrangements typically involve a hybrid partnership between the individuals and a new company, as well as using a trust to move beneficial ownership of the properties but not the legal titles.

HMRC, along with the majority of the tax profession, do not believe that these tax planning arrangements work. They are now actively challenging landlords who have used such schemes and seeking settlement of tax underpaid, which could be hugely significant sums.

Given the potential tax implications of moving property into a limited company, early discussion with a property tax specialist is essential to ensure that no unforeseen tax liabilities arise and that all available reliefs are utilised. For more information, contact Ian Pring on 01752 666601 or email him at ian.pring@westcotts.uk.