There’s been lots of talk about incorporation (setting up a limited company) to provide a tax shelter for your investment properties. There are some figures now being bandied about by lenders, one I saw this week says that up to 40% of mortgage applications are now being made for companies. It’s a figure that looks exaggerated to me, but certainly more landlords are considering it, and some lenders are providing these sorts of mortgage products.
The usual reason for incorporating is to reduce risk through the limited liability a company affords, not to cut your tax liabilities. Any business with real risks attached to it should be incorporated; after all you don’t want to lose your house and everything you own if you have a big claim against you as a sole trader or partnership.
But generally, buy-to-let does not pose any real risk to landlords, unless you fail to insure properly. The biggest risk that buy-to-let landlords face is having an injury claim from tenants or visitors to your properties, or secondly, losses through fire or flood, so having a good landlord’s insurance policy in place is vital.
The reason most landlords are now considering forming limited companies is to avoid the mortgage interest relief restrictions starting from next year (6th April 2017), because companies will not be affected by the new rules.
It would seem a neat solution: form a limited company, a process which is relatively inexpensive; in fact you can do it yourself online for around £20, plus you get the added protection of limited liability, but it might not be all it seems, there are pros and cons to be considered.
There’s a lot to consider before transferring your properties into a company. Incorporation is not a step to be taken lightly and not something you should do without expert tax advice because it won’t benefit everyone. What you do next regarding your “incorporate or not” decision has implications not just now, but for years to come.
The new tax regime
The new tax regime introduced by George Osborne last year has some far reaching implications for landlords, not least the one that means mortgage interest cannot be treated as an expense; this in turn means that with all your rent value being added to income, some landlords are going to be pushed into a higher rate tax category.
In mitigation this is not going to happen all at once, it will be phased in over a 4-year period, starting next year with a 25% reduction in relief, then 50% the year after until, 100% is reached in 2020, and with an overriding concession for everyone, regardless of your tax band, of a basic minimum rate (currently 20%) tax credit allowance for mortgage costs.
Plus, there are two further mitigating factors to this tax change: those on low earnings, those with earned income and rental income combined below the higher rate tax threshold – currently over £43,000 – and those with little or no mortgage debt, will be largely unaffected.
But for those higher rate tax payers with a mortgaged portfolios of properties, their effective income tax rate in theory could reach in the region of 60%-75%. This is when the full impact of the changes hit after 2020, making some property investment businesses not really viable.
You can perhaps see why the Chancellor did it; he wanted to cool down the buy-to-let market and his target was the serial investor building up large portfolios of highly geared properties, on the back of generous tax reliefs. This became a political issue, with many seeing this as unfair, reducing the number and increasing the cost of properties available for first-time buyers. Whether this will make a difference, or whether it will just push up rents for tenants is another matter?
There’s been a lot of opposition to the new tax regime, including the possibility of a judicial review, and with a new Chancellor in place, who know what might happen next, what changes he may make? However, for now we must assume the status quo.
For those high rate taxpayer landlords with large mortgaged portfolios, incorporation, where all mortgage interest would become fully tax deductible, could be the answer, depending on their personal circumstances.
But this will not be all plain sailing: for a start when the Chancellor introduced the restrictions on mortgage interest relief, he also introduced new dividend taxes for companies, starting from April 2016. It means that extracting income from companies will be more expensive in future, so you would need a large portfolio to make incorporation cost effective. Another factor is how the money is to be extracted: as a wages or dividends, or how much of the company profit will be left in the company to accumulate over time. These variables all need to be factored into the viability equation.
Next come the tax issues of transferring a portfolio into a company.
Capital Gains Tax (CGT)
When you transfer properties into a company you are effetely selling them to the company. If you have made gains at the point of sale, CGT might result in a large tax bill, depending on the amount of the gain – this alone could stymie your tax saving plan.
There is a slender hope here. Something called Incorporation Relief. Section 162 of the Taxation of Chargeable Gains Act 1992 says that a capital gain can be “rolled over” into the company and only paid when the company sells the asset. However, there is no real certainty in this – every case will be assessed by HMRC on a case by case basis. You won’t know for sure until your self-assessment returns are submitted. There is a history of them challenging rental business transfers, though a test case (Ramsey v HMRC 2013) gives you some hope, as HMRC lost when the landlord met certain criteria. Basically, you need to show this is a true business, not just a side-line, it must represent all your property interests and constitute your main occupation.
Stamp Duty Land Tax (SDLT)
As the company is effectively buying your properties, SDLT would be payable when the properties are transferred. Again this payment may be substantial and enough to stymie your plans. One possibility though is where the transfer is between “connected companies”, for example where you currently operate as a true partnership business. If you can establish that a genuine partnership business exists, and has existed for some years, with a minimum of two partners, both of which derive their main income from that business, and other important criteria are met, then it may be possible to avoid SDLT on transfer.
The Company Mortgage
Re-financing, once the properties are owned by the company, can be a big hurdle for most landlords. Most lenders will not simply allow you to transfer the interest you have in the property to the company under the same mortgage – a new mortgage will need to be issued, and your existing lender may not be comfortable with this. Re-financing in this way may mean losing the preferential rates you have with an existing lender, thus increasing your monthly payments to the point it makes no sense financially.
Two options here: you could offer to personally guarantee the mortgages placed in the company’s name, or you could search the market to find a deal which may “stack-up” with one of the lenders offering company mortgages, which may still involve some sort of guarantee.
Incorporation certainly won’t be for everyone. In fact accountants say that the majority of portfolio landlords will not benefit from incorporation. If you are considering this you must get expert advice to make sure (1) that your strategy has long-term viability and (2) that whatever changes you make will be acceptable to HMRC. It is possible to get a “pre-app” if you like, pre-clearance from HMRC about your potential CGT and SDLT liabilities.
Companies don’t come without running costs. Although it is inexpensive to do a DIY company set-up, in this situation it’s not advisable. First off you need some expert advice and an accountant capable of structuring the company documentation advantageously. You should budget for a bill in the region of £2000 plus initially – always get a quote. You also need to factor in on-going company accounts and returns costing £600 to £1000 every year.
There are other ways of saving on property tax without the fairly drastic step of transferring a portfolio into a company.
If you have a full-time high income occupation, as well as a large portfolio, you might consider retirement if the time is right, or reducing your time in employment and putting more time and effort into building the property business, perhaps buying any new addition properties within a company?
You should consider splitting your investments with your spouse, if you have not already done so. Joint ownership means you can claim two lots of basic tax relief, and it should reduce the overall tax liability.
Pay down debt. By paying down your mortgage liabilities, either by re-balancing your portfolio, ideally selling off the less profitable properties, or using current income / savings, you will reduce your dependence on the mortgage interest relief.
If you have family willing to take on the responsibilities of running the property business after you retire, then a strategy of bringing them in as directors of your limited company may work for you and make sense from an inheritance tax point of view. By gradually transferring properties into the company piecemeal over a number of years, progression when the time comes could be a smoother more tax efficient prospect.
Find a good property tax accountant before you consider any of this. You need one with experience of property tax and property tax planning.