By Louise Misiewicz
Updated and relevant for 2017/18
Are you frustrated by the government’s recent attacks on property investors?
Are you thinking about incorporating your property business to avoid some of the worst effects?
Budget changes mean more tax
The budget announcements have caused property investors who own property in their personal name a huge headache, one that in some cases will see them making a loss on their property investments. I have covered Section 24 mortgage interest relief cap in greater detail in a previous article, but to summarise:
- Mortgage interest relief is to be capped at 20% tax relief (even for higher rate and additional rate taxpayers)
- Income tax is to be calculated on property-related earnings before deducting mortgage interest payments, which will push many basic rate taxpayers into higher tax brackets
- A 3% stamp duty surcharge applied to second properties
We wrote a lot more detail of how Section 24 mortgage interest relief cap will affect most landlords in our article. You can see for yourself to see how Section 24 will affect you by downloading our very own tax calculator.
However, by incorporating your property business you would be able to:
- Continue to offset 100% of the mortgage interest costs against your property income
- Pay 17% corporation tax instead of the current 19% by 2020 (and George Osborne announced recently that this would fall further to 15% in future, although whether or not this will still happen is unclear now he’s no longer chancellor)
Download our tax efficient property investment guide for 2018 here
OK, OK, how do I incorporate?
Before you rush off to move all your properties into a limited company structure, you should think about the tax implications. When a property changes ownership it usually becomes liable for capital gains tax (CGT) and stamp duty land tax (SDLT), but if you’re genuinely spending the majority of your time running your property business, you may be able to avoid this.
Capital gains tax incorporation relief – Ramsay 2013 case law
As the 2013 Ramsay case showed, you can mitigate CGT provided you can demonstrate that:
- The property business is a genuine activity that provides income from the profits being generated form the activity.
- The people in the business carry out work such as performing repairs, collecting rents and dealing with tenants. The Ramsay case shows that they worked 20 hours in the business. We need to be mindful that the court decision was a qualitative measure rather than quantitive. Saying that you spend 20 hours per week going to network events, courses and estate agents misses the point that you do not look after the tenants or the maintenance of the property. As such this time is irrelevant. You therefore need to look after the tenants and not use a letting agent and organise the maintenance and repairs of the property , again not a letting agent.
- You can use a letting agent to find tenants but you should then take over the management activities.
If you can demonstrate the above then you can claim incorporation relief, which means that you pay no CGT.
Stamp duty land tax (SDLT) relief on incorporation
If you are working full-time in property and incorporate your property business then you will avoid CGT because of incorporation relief, but you will still pay SDLT, which has become a greater issue now the 3% surcharge mentioned above is in place. However, there is a way this can also be avoided.
You will need to jump through a few more hoops as I outlined in a previous article in more detail. In basic terms, you will need to move your properties into a partnership with two or more people before setting up a limited company.
As with CGT relief, the property activities must be providing the majority of your income and be deemed a business as mentioned above. Luckily, a husband and wife count as two partners.
Avoid tax when incorporating — step by step guide
If your property income is the most significant income for you and your spouse then you can incorporate your business without incurring huge tax bills, but to benefit from the CGT and SDLT savings you will need to:
- Create a partnership between you and your spouse through HMRC
- Submit your self assessments in the most tax-efficient way by allocating the majority of the income to the lowest rate taxpayer for two to three years
- After two to three years set up a limited company with the support of a lawyer to incorporate your properties into the limited company
- You will then no longer need to submit self assessments for your properties, but you will need to submit annual accounts and corporation tax returns for your limited company. Please note that you will be still required to complete self assessments as you will be a director of the business.
Obviously this method will take longer to set up than simple incorporation, but the changes to mortgage interest relief after being phased in over a four-year period starting next year, so if you get started now then by the time they are fully in force you’ll have moved to a limited company structure.
Please note there is one caveat and that is that your mortgage lenders will need to be consulted with before you embark on the above process. To date, most mortgage companies have not liked the above approach and some will insist that you refinance, which means you may end up paying additional fees and you may lose the attractive interest rates that you originally secured.
Why you should not incorporate your property business
We have written a separate article on the reasons why you should not incorporate your property business. There are benefits of incorporating but there are always two sides of a coin. You can go through all the above hoops only to find that incorporation has not saved you all that much money when you compare the costs of time and money to the benefits.
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