Are you thinking about using a limited company and want to avoid CGT & SDLT?
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 changing ownership from your personal name into a limited company
- Any Capital Gains Tax (CGT) that you will have to pay, ie, the difference of the market value now and the price that you paid for the property, less any 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 (BTL) 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.
This is because 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.
Practical steps you should now take to transfer properties into a limited company
It is one thing to understand the theory but it is another to put it into practice. The sole purpose is to avoid Section 24, CGT and SDLT. This is why I with the help of my property accountants have written a step by step guide to implementing this strategy:
- Identify properties that have little rental profit and have small CGT gains
- Identify properties that have a high amount of mortgage interest that could push you into being a higher rate taxpayer
- It is also worth looking at properties that are not making you any money, using formulas like Return On Investment (ROI)
- Work out how much the redemption penalties you are likely to pay are and also add on any additional new fees from using a commercial loan/mortgage through the limited company
- Work out how much SDLT tax you will pay by transferring properties into a limited company
- See if you can actually get a commercial loan/mortgage
- Set up a limited company
- Transfer the properties from your own name to a limited company using a property savvy solicitor. Put money aside for any CGT owing
You may be able to mitigate CGT altogether if you can prove that you are working full time in the property business by claiming incorporation tax relief. It would be wise for you to work with one of our property accountants to get this right.
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