Since the announcement made in the 2015 Summer Budget introducing a restriction on the tax relief provided on mortgage interest for individuals, the most common question we have been asked is “Should I incorporate my Buy to Let Property Business?”. Translated this is simply, “should I put my property portfolio into a company?”.
This is not a surprise – these measures, which have been being phased in since 6 April 2017 and which came into full force from 6 April 2020, can lead to significant additional tax for higher and additional rate taxpayers with mortgaged buy to let properties.
The interest restriction does not apply to companies, which makes them an attractive option. But what makes them more attractive still is that companies pay tax on profits at just 19% as opposed to 40% or 45%.
The process of setting up a company is relatively inexpensive. However, there is a lot to consider before you do.
Every case is different, but there are some fundamental questions that need to be considered before someone can give you a direct answer to those.
These are the questions we would ask and the reasons why.
What are the properties worth?
Usually the biggest up-front cost involved in transferring a property into a company is SDLT (Stamp Duty Land Tax). Usually SDLT is calculated based on consideration. However, where properties are transferred into a company that you are connected with, SDLT is calculated based on the market value of the property.
The rate of SDLT payable will be between 3% and 15% depending on the value of the property. As this is often a dry tax charge (i.e. one that does not generate cash), it can be a significant barrier to incorporation.
Fortunately there are ways to mitigate the SDLT payable or even eliminate it altogether. These only apply under very specific circumstances and can take time to achieve. For example, on incorporating a partnership, a relief can apply that reduces the SDLT payable to nil. If that is not available, it may be that the transfer attracts a lower rate of SDLT because either multiple properties are being transferred at the same time or the properties have a mixed use.
Incorporating can trigger other ongoing taxes, such as ATED (Annual Tax on Enveloped Dwellings). All properties worth more than £500,000 need to file an ATED return each year. The good news is that the charge only applies where the property is available for use by the shareholder or someone connected to the shareholder (even if that person does not use or pays market rate for its use). So, if the property is being used for letting to a third-party tenant or is being held as stock for development and is not available for use by the shareholder, there should not be an ATED charge.
The charge starts at £3,700 per annum for properties worth £500,000 to £1 million. The charge increases in steps and for very valuable properties this can be as high as £236,250 per year!
Have they increased in value?
The value of your property may have increased significantly during the time of ownership. This could trigger a Capital Gains Tax (CGT) charge. Where CGT is payable, the rate is currently between 18% and 28% on the difference between the market value at the time of the transaction and your allowable costs. Any CGT payable will be reportable and payable within 30 days of completion.
Thankfully, there may be reliefs available which could reduce the tax charge to nil. The most common is where you are running a business – which means you are doing more than just renting out the property. If you are, you may be able to hold over any gain and not pay the tax until the company is sold.
Of course, if you have been occupying the property as your main home for at least some of the period, the gain will be reduced as it will attract principle private residence relief.
How may properties have you got?
The more properties you have the more likely you will be deemed to be running a business and therefore stand a better chance of qualifying for hold over relief on transferring your properties to the company. Whilst not a silver bullet, it is certainly very helpful.
Of course, you will need to factor in any additional costs of operating through a company such as the need to prepare and file company accounts with Companies House as well as annual ATED declarations.
Have you spoken to your mortgage provider?
You also need to consider the practicalities of changing to corporate ownership. Will your mortgage provider allow you to transfer your existing mortgage to a company? If not, there may be penalty clause for changing your product. The rate of interest on a new product may be higher. Again, it may be that the income tax savings are wiped out if the costs of changing your mortgage terms are high.
What do you plan to do with the profits the business generates?
Once the company owns the property, it also owns the income generated. Will you still need access to that cash? Or do you plan to leave the money in the company for it to accumulate and/or be reinvested?
If you need to draw on the cash, then you will need to decide on a strategy for doing that. You could choose to draw dividends or a salary but those will have an impact on your personal tax position.
What are your long-term objectives?
If the plan is not to draw out the profits, then being able to reinvest within the company may be tax efficient for you as profits generated within the company will only attract corporation tax at the rate of 19% – far lower than the possible income tax rates of 45%.
You may want to pass the value on to your children. There are ways that this can be done which mitigate the immediate tax impact but need careful consideration.
You may of course simply want to sell all the properties and extract all of the profits. On the face of it, doing this can unwind some of the tax benefits but, that analysis ignores the lower tax regime that those profits have accumulated in whilst being held as a company.
If you want to live in the property, putting it into a company is not a good idea as if it is worth more than £500,000, living in it will trigger an ATED charge.
How can we help?
The best place to start is to answer the 6 questions above and then come and speak with us. We can then help you review your personal circumstances, and provide you with advice on the best solution for you. If you would like to speak to someone to discuss your circumstances, then please contact a member of the tax team for further information.