Posted by RoosterCreativeMarketing on 26 Jul 2021
Incorporation of Property Portfolio
There are still benefits to incorporating a property portfolio into a limited company, despite a proposed increase in the rate of corporation tax.
Owning a property portfolio through a limited company can offer significant benefits; such as reducing the rate of tax that is applied to rental profits and side-stepping the restriction on tax relief for mortgage interest that applies to properties held personally.
Tax benefits of owning property through a limited company
- Profits and gains are subject to corporation tax at 19%, rather than income tax at up to 45% or capital gains tax of 28%. Corporation tax is due to increase to 25% from April 2023, but this is not a certainty.
- No personal tax liability if rental profits are reinvested within the company (on mortgage repayments, improvements, or new property acquisitions) rather than drawn out for personal use.
- The restriction on tax relief for mortgage interest, that can lead to an individual paying tax on rental profits that do not really exist, does not exist for companies – full relief is available against corporation tax for mortgage interest paid.
Obstacles to transferring properties into a limited company
Unlike a partnership, a company has a separate legal and tax existence and transferring properties to a company can trigger tax charges that may outweigh the potential benefits:
- Transferring properties to a company that you own will normally trigger capital gains tax as if you had sold the property at market value.
- Transferring properties to a limited company can trigger an SDLT charge for the company, based on the market value of the property at the time of the transfer.
In addition, as the company is a separate legal entity, any existing mortgages will need to be replaced (although sometimes this can be deferred until the end of any fixed mortgage period).
The capital gains tax charge mentioned above can be avoided if the property portfolio being transferred is a business for tax purposes. The difference between a property business and simply having property investments is largely down to the number of properties and the amount of time it takes to manage the portfolio.
Case law has shown that property letting may consist of sufficient let properties and engagement by the owner to constitute a business and the Ramsay case is the main piece of case law in this respect. In that case, Mrs Ramsay devoted some 20 hours a week on managing the portfolio and had no other occupation during this period. The court decided that the level of activity, and taking the activities of the taxpayer “in the round”, was sufficient to deem her work in respect of the portfolio as being beyond the mere passive receipt of income and therefore satisfied the “business” test for the CGT relief. On this basis, HMRC generally take the position that where a person spends 20 hours a week working on the property portfolio, a business exists. This will obviously require the portfolio to consist of more than a handful of properties; if your property portfolio consists of a small number of properties, you may have a hard time convincing HMRC that you spend 20 hours a week working on the portfolio.
If the portfolio is a business, it should be possible to transfer the entire business to a limited company in exchange for shares in that company, without triggering capital gains tax. Instead, the shares that you receive in the company will have a reduced base cost for tax purposes, meaning that capital gains tax may instead be due on any future disposal of those shares. However, the company is deemed to have acquired the properties at their value at the date of incorporation, meaning the company will be taxable on any future growth in the value of the properties, but not the growth prior to incorporation. You will have transferred the properties into a limited company without incurring any capital gains tax at that time.
Stamp Duty Land Tax and Partnership Incorporation
While incorporation relief can avoid capital gains tax on moving properties to a company, SDLT will still be due, unless you are not just incorporating a business, but rather a partnership. A partnership is a business that is carried out by two or more people, and unlike a business carried out by one person, does not trigger SDLT when it is incorporated into a company in exchange for shares.
In addition to demonstrating that a business exists, the partners of a partnership must show that they are in business together. This means that they must each, separately have sufficient scale to their property activities that they are each in business rather than holding investments (such as that each partner spends at least 20 hours a week on managing the portfolio), and they must have a partnership agreement, a partnership bank account, and have registered the partnership with HMRC to demonstrate they are in business together.
Anti-avoidance relief is in place to stop partnerships from being formed simply to benefit from SDLT relief on incorporation. It is widely considered to be sensible to ensure that a partnership exists for at least 3 years before even considering incorporation. This requires you to be able to demonstrate that a partnership exits before this 3-year period starts.
Incorporation and Inheritance Tax
Companies are often protected from inheritance tax (IHT), leading people to assume that incorporating a property portfolio will avoid IHT. Unfortunately, the tax reliefs that are typically available to company owners do not apply to people who have incorporated a property business into a company. If you incorporate a property business into a company, the value of those properties is still in your estate for IHT purposes, as the shares you own will reflect the value of the assets held by the company.
This is not to say that there are no potential IHT benefits to incorporation. It may be that the use of tailored types of share may offer long-term IHT protection of future growth in the value of the properties. In addition, borrowing on the property can sometimes create a loan account that can reduce exposure to IHT.
Role of Tax Innovations
There are significant benefits to moving your property portfolio into a limited company, but there are also traps to be avoided. Tax Innovations can provide assistance with all aspects of incorporation transactions including:
- Ascertaining the tax costs and tax savings of incorporation, including making you aware of the long-term consequences.
- Helping you identify whether a business exists and how this can be proven if necessary
- Assisting with proving the existence of a partnership, including preparing a partnership agreement that will be effective for tax purposes.
- Working with your solicitors and lenders to carry out the incorporation so that the conditions for relief are met and that the transactions are correctly reported.
- Providing additional advice into any appropriate inheritance tax planning opportunities that may arise.
If you would like any advice regarding Incorporation Relief on property or would simply like to discuss other ways in which we could help you or your business, please contact us on 01962 856 990 or firstname.lastname@example.org.