Your property tax questions answered – incorporating properties into a limited company
In this article we are going to try and answer the following questions:
- Can I transfer my property into a limited company?
- Should I incorporate a rental property?
- How do you incorporate a partnership?
- Can I sell my house to my limited company?
- What Capital Gains Tax will I pay by moving properties into a limited company?
- What Stamp Duty Land Tax charges will apply when I incorporate my property portfolio into a limited company?
Whilst you are reading this article you may wish to read our page on the subject of “buy to let tax for UK landlords” where we discuss all the different types of tax that you need to be aware of. Read Here for more (opens in a new tab)
Section 24 mortgage interest relief cap means that you are likely to pay more tax
I’ve previously written an extensive article that demonstrates that many people will pay more tax on their property portfolio after the budget announcement of 2015. There were a number of changes that reduced the costs that could be offset against your property income, including:
- The restriction of mortgage interest relief to 20%
- Removal of the 10% wear & tear allowance
You can see how Section 24 will affect your cash flow by downloading our tax calculator. We discussed in another article how Section 24 mortgage interest relief would affect property investors and what they could do about it.
If you are a higher rate taxpayer then you will pay a lot more tax. If you have an income of circa £20K with mortgage interest costs of circa £40K then you could be moved from being a basic rate taxpayer to a higher rate taxpayer. It may be worth considering transferring your property portfolio to a limited company.
Considerations when selling a property to a limited company?
Many clients ask the question -“Can I sell my house to my limited company?”. The simple is yes of course. When you sell a property to a limited company there are issues around:
- Any Capital Gains Tax (CGT) that you will have to pay. This is the difference between the market value and the price that you paid for the property. This is further decreased by the capital refurbishment costs. I have written a more detailed article on this.
- Any Stamp Duty Land Tax (SDLT) costs that will be incurred by transferring the properties into a limited company. Again I have already written an article on this
- The redemption penalties that you will incur by paying off your existing Buy To Let mortgages early
- The solicitor fees incurred by transferring the properties into a limited company
- Any additional accountancy fees of running the limited company
- Any additional interest that you are likely to pay by using a commercial mortgage for your limited company over and above the buy to let (BTL) rates that you pay when holding properties in your own name
- The additional arrangement fees that you will pay using a commercial mortgage
Download your property tax guide here, written by our property accountants
A real life client example — paying more tax because of the budget announcement (using 2015-16 rates)
For the purpose of this article, we are going to name my client John to protect his identity.
John earns £35,000 from his employment income and £5,000 from his property portfolio. He does not think that he will be affected by the budget changes because he is not a higher rate taxpayer. But he is wrong because this is how his property business is illustrated:
£45,000 property income
£35,000 mortgage interest rate costs
£5,000 other costs
John’s tax liability would have been £5,880 in the pre-budget announcement world. Now, with the budget changes, his tax will increase by £6,523 because of Section 24 mortgage interest relief cap.
Before the tax changes, mortgage interest was subtracted from property income before tax was calculated. Under the new system, tax will be calculated on the property income before mortgage interest costs are subtracted, then a rebate of 20% of the mortgage interest will be added back. So John’s taxable income jumps from £40,000 to £75,000 and he has thus taxed a much higher proportion of his income.
If John was to buy more properties, then he would also pay 40% tax on any further profit that he makes.
In 2015-16 the higher rate taxpayer band kicks in at £42,836. Under the new rules, that is the point at which John would be paying 20% more tax on the paper profits even though in reality he is making less than £42,386. Our property accountants have been helping their accountants have been working with their clients to ensure that the impact of Section 24 is minimised. Clearly one of the areas of focus has been to transfer properties into a limited company.
CGT mitigation through the incorporation
You will be liable for CGT based on the profit you have made when transferring the property into a limited company, regardless of the price paid by the company. Even if you gave the property to the company for £0 you will be deemed to have transferred the property at market value.
For example, Mr A transfers his property for £0 to his limited company
- £200,000 deemed market value of a property
- -£100,000 cost of property
- £100,000 taxable gain
Some time ago our property accountants wrote an article about incorporation relief referencing a specific case “Ramsay v HMRC (2013)”. HMRC insisted that a couple should pay CGT because they transferred their properties into a limited company.
Mrs Ramsay demonstrated that she and her husband spent at least 20 hours per week on their property and as such proved that they were in fact in business.
Judge Roger Berner said in the appeal hearing: “I am satisfied that the activity undertaken in respect of the property, again taken overall, was sufficient in nature and extent to amount to a business for the purpose of s162 TCGA. Although each of the activities could equally well have been undertaken by someone who was a mere property investor, where the degree of activity outweighs what might normally be expected to be carried out by a mere passive investor, even a diligent and conscientious one, that will in my judgment amount to a business. I find that was the case here. For the reasons I have given, I allow this appeal.”
No SDLT charge when incorporating properties from a partnership into a limited company
Here is an example of where there will be no SDLT charge:
A partnership of A and B has relevant partnership property including a commercial unit and various shareholdings in several limited companies. The commercial unit has a market value of £1.5 million subject to an outstanding buy to let mortgage debt of £500,000 and the shares have a market value of £180,000.
C joins the partnership paying £300,000 for a 25 per cent share.
HMRC states that the liability will be based on the consideration given less the excluded amount.
Firstly we need to establish the net market value of the chargeable interest:
- MV – SL
- MV = £1.5 million
- SL = £500,000
Net market value equals £1 million.
As C was not a partner before the transfer this will be equal to the partnership share he acquired, i.e., 25%.
The excluded amount is therefore:
25% x £1m = £250,000
To establish consideration for SDLT purposes we look at the consideration passing less the excluded amount:
£300,000 – £250,000 = £50,000.
This will be the consideration for SDLT purposes.
As the SDLT consideration is less than the 0% threshold, if a certificate of value at £125,000 is included in the instrument, the SDLT liability is nil. This doesn’t take into account the 3% SDLT surcharge implemented in 2016.
In reading the provisions of Sch 15 FA 2003 it is necessary to distinguish between the actual consideration given for the acquisition of a partnership interest and the “chargeable consideration”. This is because it is the “chargeable consideration” that determines the extent of the SDLT charge on the acquisition.
Buy to let mortgage companies and their view of the incorporation
A number of people are stating that you do not need to inform your mortgage companies when incorporating.
Buy to let mortgage products are not regulated by the Financial Conduct Authority (FCA). As such the banks will lose out if you move the properties into a limited company without telling them. Do you think they will be impressed? The mortgage interest costs are typically higher if you have properties in an incorporated business. They will also be looking for some sort of administration fee to transfer the properties into a limited company.
Some lawyers and accountants are suggesting that the banks will not do anything because you are paying the mortgage. Banks can make more money from other clients nowadays compared to you. This is especially the case where you have a buy to let mortgage of less than 4% interest. Do not give them a good reason to pull the mortgage out from under your feet.
We discussed how property investors may reduce Stamp Duty Land Tax in another article.
A step by step guide of how to incorporate your properties into a limited company via a partnership
1) Complete the Partnership
- Online registration if you have a government gateway login: SA400 and SA401’s and then send to HMRC. HMRC will then provide a Unique Tax reference code for the partnership.
- Forms if you do not have a government gateway login: SA400 and SA401’s and then send to HMRC. HMRC will then provide a Unique Tax reference code for the partnership.
2) Prepare a partnership agreement (we recommend utilising the support of a solicitor in drafting this important document). This document needs to outline the amount of capital contributions as well as the flexibility each year to allocate profits based on the efforts put into the partnership (as you see fit). You and the solicitor need to ensure that the partnership agreement and arrangement is watertight to ensure it does not fall into HMRC’s definition of “Sham partnership” (just to avoid tax.
3) Submit 3 years worth of self-assessments for the partnership. Please note that any property revenue losses upon incorporation (ie those you can use to offset in the year) will then be lost as they cannot be offset against partnership profits.
4) You will need to work with your mortgage broker/banks to arrange finance in the limited company to replace existing mortgages. This may take some time so it is best to start this process nine months in advance of the incorporation date
5) Once 3 years worth of partnership accounts has been produced it is now possible to incorporate the property business into a company. The share allocations will be based on the capital contributions from part 2 to ensure that there are no CGT/SDLT issues. The share values will be based on the net assets of the partnership.
6) You will need to work worth us/your solicitor to agree on what you do with the “Directors loans” and any Latent Gains for Capital Gains Tax purposes. This is based on the mortgages in place that are greater than the original acquisition costs of the property portfolio. This is otherwise known as a capital account.