Writing for The Jewish Tribune, our Director of Property Taxes Andrew Levene explains the tax pitfalls for landlords looking to transfer personally owned property to a company.
The era of low interest rates has triggered huge investment in buy to let residential property. Typically this sort of property was acquired by landlords in their personal names. We are now seeing an increasing trend of landlords looking to transfer their personally owned property to a company. From London to Gateshead, everybody seems to want to incorporate!
The most recent trigger for this was the penal interest rules for personal landlords. These give landlords a deduction for interest at 20% even though their rents are being taxed at the higher rates of 40% or 45%. This can lead to very high effective rates of tax – sometimes the tax bill can turn a positive net cashflow before tax into a net cashflow after tax. This is becoming a more significant issue as interest rates rise.
The other big driver of incorporation is that the corporation tax rate of 25%, or lower than 25% for smaller portfolios, is significantly lower than the higher personal income tax rates of 40% and 45%.
Historically, mortgage deals available to companies were less attractive than those available to personal landlords. But this is changing as the banking market responds to the increased demand for company finance.
It is however important to take proper tax advice before proceeding with an incorporation.
The right option?
Although for many landlords incorporation is the right way forward, it is not the right solution for everyone. In my experience as a property taxes adviser, for about 50% of clients incorporation is not the right way forward or offers only marginal tax benefits relative to the risks and downsides of incorporating. This is particularly the case where the landlord needs the rent from his portfolio to live on. In that case, payment of dividends from the company can mean more overall tax than leaving the properties in personal ownership. There can also be disadvantages when selling properties or for estate planning purposes.
Incorporation is normally most beneficial for highly geared portfolios as it can minimise the pain of the buy to let interest rules. Again this is becoming an increasing issue as mortgage rates rise.
Anticipating the tax pitfalls
Having decided to incorporate, many landlords assume that it is a simple matter of drawing up a property transfer form or trust deed to transfer ownership of the properties. Unfortunately this is far from the case for tax. A transfer of properties to a company is treated for tax purposes as a sale by the owner to the company with the sale being deemed to take place at market value. This means that there is capital gains tax (CGT) for the landlord and stamp duty land tax (SDLT) for the company.
Where the portfolio constitutes a business, it is possible to eliminate the CGT charge for the landlord by claiming incorporation relief. HMRC generally accept that a portfolio constitutes a business if the owner works at least 20 hours per week on the portfolio. There is little legal basis for this view and it should be possible to argue that a business exists even if the owner doesn’t work 20 hours per week in it. But the exact definition for a business to exist is not entirely clear. There are also ways of avoiding the SDLT charge on transfer.
Another mistake is transferring properties for debt rather than shares. Transfer for debt is attractive because it creates a loan due to the individual which can be repaid to extract funds from the company. The difficulty is that incorporation relief can only be claimed in full where the transfer of properties is for shares. Therefore the landlord has to decide between a tax-free transfer of properties or a more tax-efficient structure going forward.
We have seen situations where an individual has simply transferred properties to a company or transferred them for a debt without paying any CGT or SDLT and without claiming any reliefs and HMRC has picked up on this. At this point there is often very little choice but to pay the tax. So it is always better to seek specialist professional advice before incorporating.
Another trap for the unwary is the strategy of transferring properties by a deed of trust. This is a mechanism whereby the legal title to the property is left in the name of the individual who, going forward, holds the properties as nominee for his company. This is a perfectly legal device and achieves transfer of ownership of the properties for tax purposes. The problem is that it isn’t possible to transfer the mortgage in this way. The mortgage stays with the individual and this can create issues around claiming incorporation relief and also tax deduction for interest paid to the bank.
Another danger to watch out for is specialist property incorporation boutiques claiming all sorts of magic benefits on incorporation. To be fair to these firms, the claims vary from slick marketing of legitimate benefits to ideas that simply don’t work.
Dan Neidle of Tax Policy Associates is a former tax lawyer who now spends his time publishing details of ‘dodgy’ tax schemes being peddled that he thinks don’t work. He has recently picked up on some of the schemes being offered by these property boutique firms. HMRC have also picked up on these in their Spotlight publication, which focuses on identifying tax schemes being marketed that HMRC thinks don’t work. So again, it is wise to take proper advice before engaging with these firms.
One of the problems with the focus on schemes that don’t work is that even plain , ‘completely Kosher’ incorporations are likely to come under review with HMRC checking that conditions for relief are met.
Having said all that, we are not trying to put you off incorporating your property portfolio! Rather, we are encouraging you to take proper advice on whether it’s the best course of action, and on the best way to implement it without risking a tax bill with unpleasant surprises.
This article was originally published in The Jewish Tribune (New Issue No. 291/MMDCLXXVII, 3 January 2024) as part of the Talking Tax series. It’s also available via the Jewish Tribune website.