Many landlords will have seen profits squeezed in recent years. Higher mortgage rates, the restriction on tax relief for finance costs, stagnated personal allowances and tax bands, have all conspired to reduce the net yield for landlords. Some may have chosen to increase rents to cover these costs, but this is not always possible, particularly in difficult economic times. These issues may force landlords to reconsider their position. In the following article we discuss some of the issues for property ownership and the options available.
Mortgage finance restriction
Since April 2020, tax relief on mortgage interest for residential property (not furnished holiday lets or commercial property) has been restricted and the maximum relief available is now 20%.
Furnished holiday lets – Spring Budget 2024 changes
Historically, furnished holiday lets have received certain tax advantages compared to standard residential lettings. This included full tax relief for mortgage interest, preferential 10% CGT rate (under Business Asset Disposal Relief), tax relief for pension contributions and tax relief for certain capital expenditure.
In the recent budget, it was announced that from 6th April 2025, these preferential tax treatments will be removed and furnished holiday lets will be treated as normal residential lettings. This may result in landlords with these types of properties reconsidering their position. Perhaps selling to obtain a preferential CGT rate before the changes or incorporation (see below).
Incorporation into a limited company
The finance restrictions for mortgage interest do not apply to limited companies. Therefore, when these changes came into effect, many landlords were looking at the possibility of incorporation. There are significant challenges with incorporating an existing property portfolio. These are discussed below.
Capital gains tax
The transfer of property owned personally into a corporate structure is a deemed disposal for capital gains tax purposes and the transaction takes place at market value. Capital gains tax (CGT) is payable at rates of up to 28% on gains above £6,000 in the current tax year (2023/24) and above £3,000 from 6th April 2024. The top rate of CGT for residential property gains is due to be reduced to 24% from 6th April 2024.
Incorporation relief
Incorporation relief may be available to defer the gain, but this would depend on whether holding the properties qualified as being a business or whether it was an investment activity. The main conditions of incorporation relief are:
- the business is transferred as a going concern
- all the assets of the business (with the possible exception of cash) are transferred to the company, and
- the consideration for the transfer of the business is wholly or partly by the issue of shares to the seller.
Property letting activities can be treated as business if they are substantial. There is no definition in the legislation of what substantial is but the main tax case for this is the Ramsay case where it was held that the activities must:
- represent a seriously pursued undertaking
- be conducted on sound and recognised business principles
- be of a type that is commonly made by those who seek to profit by them, and
- be of a significant nature with a reasonable period of time being spent on property-related activities. In the Ramsay case, this was 20 hours a week personally undertaking the sort of activities that are indicative of a business.
This is a difficult relief to obtain, and claims are very likely to receive full scrutiny from HMRC.
Stamp Duty Land Tax (SDLT)
If the new shareholders of the limited company are the same as those transferring the property, then then there will be a chargeable transaction for SDLT purposes. Moreover, companies purchasing residential property are liable to a 3% surcharge on existing SDLT rates.
Partnership SDLT relief
The transfer of a buy to let from a partnership to a limited company may qualify for what is referred to as partnership SDLT relief. For SDLT relief to apply, care needs to be taken that there is a partnership and not just jointly let property. Evidence would include a partnership agreement, partnership bank account, and leases and other agreements being in the partnership name.
It may be very difficult to persuade HMRC that a property rental partnership exists where partnership tax returns had not previously been submitted. Simply splitting the income and showing them on the land and property pages of the self assessment tax returns, may not be sufficient.
Is it worth incorporating a property portfolio?
The significant upfront costs relating to SDLT and CGT could make incorporation an existing property portfolio an unviable proposition. Further, it may not be the most appropriate structure. If most or all of the profits are going to be removed from the business anyway. The dual layer of corporate and then personal tax on profit extraction may exceed other advantages. The effective rate for the individual landlord will depend on the impact of the mortgage interest restriction. The comparison between personal and limited company depends on a number of factors, including the level of profits removed, the amount of mortgage, and the difference in lending rates offered to a company.
Retaining profits with (at most) a 25% main rate of corporation tax, along with inheritance tax (IHT) planning are the main advantages of using a limited company for a let property business. While a let property business will not qualify for IHT relief (via Business Property Relief), any future growth in the value of the business can be protected from IHT through the transfer of shares to the younger generation in the family ('family investment company'). If structured correctly, this future growth is not a gift of current value, and is therefore not a disposal for CGT purposes, nor a potentially exempt transfer (PET) requiring the donor to survive seven years.
Future issues
We are in a period of uncertainty in relation to taxation and the economy. We may see changes to tax rates in the near future and a change in government could see the landscape alter further. As an example, there is a perception that capital gains tax rates are too low and perhaps these may get more aligned with income tax rates. This would have a significant impact on tax due from property capital gains.
The next step
For any enquiries regarding the above, please contact Tom Annat on t.annat@uhy-rossbrooke.com or your usual UHY adviser.
