Lee Sharpe looks at some of the key issues on incorporating a residential property letting business.
This article will look at some of the issues that the landlord will have to evaluate in order to determine whether or not incorporation is the right solution for a buy-to-let (BTL) property business.
Capital gains tax
The transfer of personally-held assets to one’s own company will trigger an ‘event’ for capital gains tax (CGT) purposes. For a transfer of rental properties, this will be the case whether:
- the properties are sold to the company, or
- the properties are given to the company as a gift (or at a reduced value).
CGT is triggered because the ownership of the properties is transferred between two separate legal entities. It doesn’t matter that you receive nothing in return (see for example HMRC’s Capital Gains manual at CG14530, and the legislation itself at TCGA 1992, ss 17, 18).
The end result is that, whatever you receive in return for the properties if you incorporate, CGT is chargeable on the market value of the properties when they are transferred in to the company. However:
- if you have capital losses in the year of transfer, or from a previous year, they may be used to offset the gain on the properties; and
- it may be possible to claim ‘incorporation relief’ (under the provisions of TCGA 1992, s 162).
Incorporation relief
Basically, all of the business must be transferred to the new company – it is an ‘all or nothing’ claim. But in some circumstances and with proper planning, it may be possible to exclude certain properties, if that suits.
The company swaps new shares in itself for the properties. The gain is ‘held over’ into each share, and is chargeable when that share is sold, transferred or otherwise disposed of.
Even here, there is a pitfall: do not assume that eligibility for incorporation relief is automatic. You must be able to say that the property letting business constitutes a ‘business’ with substantive effort on your part, such as (for example) collecting rents, advertising for and vetting tenants, co-ordinating repairs, decorating, dealing with bad tenants, etc. If, however, all property matters are delegated to a third party letting agent then, whatever the size, it may be difficult to argue that it is an ‘active business’ that you conduct.
Example 1 - BTL business incorporation
John is an active BTL property investor with a portfolio worth £1 million as a fair market value, net of loans, etc. His ‘base cost’ for CGT purposes is the properties’ original cost, which is £400,000. He also spent £100,000, over the years, on property improvements that his accountant told him he would not be able to claim against his rental income at the time, but he could claim as ‘capital improvements’ – i.e. now, when making a capital gain.
John will therefore make a gain of £500,000 if he incorporates – CGT will be due of £140,000 (note that while the main CGT rates have fallen to 10% and 20% for those gains falling into the ‘higher rate band’, gains on residential property remain taxable at 28% (or 18% to the extent that they fall in the ‘basic rate band’).
John opts for incorporation relief instead. He instructs his advisers to set up ‘JohnCo Limited’. JohnCo Ltd issues 1,000 shares to John, in exchange for his property business.
John now has 100% of the shares in a property company, worth £1 million. His personal worth is basically unchanged. Assuming that the claim to incorporation relief is effective, each of John’s 1,000 shares therefore contains a ‘held over’ gain of £500.
If John were to sell all of his shareholding six months later, all of that gain would become taxable, together with any increase in the value of the shares themselves while he has held them (in this case, the value of the company would closely follow the value of the properties it holds).
But John has other ideas. He intends holding on to his shares ‘forever’, knowing that the postponed gain will effectively disappear on death (there are other tax-efficient alternatives, with an eye to inheritance tax planning, but these are more complex).
Stamp duty land tax*
The second significant potential tax charge is stamp duty land tax (SDLT) on the value of the properties that are transferred to a company that is ‘connected’ to you (because you will own the shares).
The charge in this case is on the full market value of the properties transferred, and mortgages are not a factor.
Due to the new SDLT rates for ‘additional’ residential properties, this may prove very expensive, even if the rates are now progressive, rather than on a ‘slab’ basis, on the whole consideration.
Band Existing residential New additional property
SDLT rates SDLT rates
£0* - £125,0000 0% 3%
£125,000 - £250,000 2% 5%
£250,000 - £925,000 5% 8%
£925,000 - £1,500,000 10% 13%
£1,500,000+ 12% 15%
A company cannot have a main residence, so the higher rates will apply automatically to corporate acquisitions. But there is a potential measure of relief for those transferring larger portfolios:
Example 2 – Multiple dwellings relief
Belinda has four residential properties, each worth £200,000. The total consideration is £800,000 so the full SDLT would be:
Band New additional property SDLT rates SDLT Due
First £125,000 3% £3,750
Next £125,000 5% £6,250
Last £550,000 8% £44,000
£800,000 £54,000
However, as she is transferring more than one dwelling, she is entitled to use multiple dwellings relief (MDR) on incorporation to pay based only on the average:
Band New additional property SDLT rates SDLT Due
First £125,000 3% £3,750
Next £75,000 5% £3,750
Average £200,000 £7,500 x4
Total SDLT £30,000
Where transferring six or more residential properties, the rate is based on the rates for commercial or mixed use properties instead.
Example 3 – Commercial rates
Bill has six properties, also each worth £200,000. Ignoring any reliefs for multiple properties, the full charge on incorporation would be £99,750. But Bill’s company has the choice of MDR, where the cost (using the average derived in Example 2 above) would be 6 x £7,500 = £45,000.
Alternatively, Bill could use the new commercial rates on the total contract value, announced in Budget 2016:
Property Consideration New Commercial Rate SDLT Due
First/up to £150,000 0% £0
Next £100,000 2% £2,000
Surplus over £250,000 5% £47,500
(£950,000 in this case)
£1,200,000 £49,500
In this case, MDR gives the better result, so this is what Bill would choose. But for investors with higher property values, the average price would start to become more expensive, even under MDR, so the ‘commercial rates’ would probably be the better option.
Other pitfalls
- Capital allowances – Although BTL businesses do not generally have a great deal of expenditure that is eligible for capital allowances, there may be some assets such as office equipment, tools or vehicles that have been claimed. Thanks to the annual investment allowance, the tax value of such assets may be very low or even nil so that, when they are transferred to a connected party – the landlord’s own company – at their current market value by default, a balancing charge arises that is taxable at the landlord’s marginal rate of tax. This may be avoided by, for example, using a joint election (under CAA 2001, s 198) to fix the transfer value at the current tax written down value.
- Loans – Landlords have occasionally told me that they will keep their existing mortgages because they have excellent rates. I suspect that the mortgage lenders will have contract provisions to require the investor to notify them of a change in ownership and in some cases this may void the mortgage contract. But from a tax perspective, I ask the landlord what he or she thinks she will now get tax relief on the mortgage for, since it is no longer their rental income, but their company’s. Basically, the loans have to be in the company, for the company to be able to claim tax relief.
- Legals – The company will now own the properties so, pending legal advice, it should be the company that is insured rather than the individual. Likewise, the investor will need to take advice on how contracts should be structured, now that the company is the landlord. Perhaps the investor will now act as the company’s agent, so that the tenant has a sense of continuity.
Practical Tip:
Some of the main issues for incorporating a BTL business are set out above. VAT should not feature significantly for ordinary residential lettings, and would be more important for commercial properties – although it is wise always to check. There are numerous issues to look out for and, as usual, good professional advice is strongly recommended – beforehand!
*The new rules for SDLT are still being discussed in the Finance Bill 2016 and may change; the position should be checked before undertaking a transaction.
