Landlords - Should you incorporate or not?

*Please note the information in this article may be out of date

Michael Wright, our Property Tax Expert, from RITA4Rent, takes a run through the decision making process to help you weigh up what the appropriate course of action is for you.

Mon, 04 Nov 2019

We need to make something clear first.  You need to understand that incorporation isn’t just a magic wand that will save you thousands in tax. Of course, for some landlords it is, but it still takes very careful planning. If you want to do it right, it’s definitely not a next-day delivery service. I often get calls from landlords whose friends or colleagues have incorporated their portfolio, and they ask if I’m able to help them to do the same. They jump right in, guns blazing, asking how long it will take to form the company and get moving.

Every landlord’s circumstances differ, and my answer is always that first, they need to figure out whether this is the right move to make.  Yes, it is possible to make big tax savings, but it may not work for all landlords. Before we explain how you would incorporate, let’s take a few steps back and check that it’s actually going to benefit you.

Why incorporate?

We first need to understand why there is such a growth in interest in operating your property through a limited company.  There are several reasons, but the most common are:

1. You would pay corporation tax instead of income tax on your rental profits, and this would be charged at 19% with further reductions in the horizon. This is a major advantage for those earning above £50,000 (and thus paying income tax at 40%)
2. Compared to owning a property outside of a limited company, you avoid the notorious mortgage interest restrictions which have been phased in since April 2017. These don’t affect companies at present.
3. To ensure your loved ones are not hit with a large inheritance tax bill.

First things to consider:

“All three apply to me! When can we get started?” I hear you say.  Wait a minute….a few more considerations first:

A company is strictly a separate legal entity from its owner (or owners). So when you transfer the property over to the company, it is essentially purchasing the property from you. This incurs two tax liabilities on each party. And what is the first one:

Stamp Duty Land Tax

If the property is above £125,000 you pay SDLT at increasing rates on the value of the transfer. You can view the list of rates and their value benchmarks here. There is also an additional rate of 3% regardless of property value, or whether the property is the company’s first purchase. So whether you have a large property portfolio made up of properties below £125k, or just one very expensive property, the initial costs of transferring your properties over to a company can be quite high. SDLT alone can be a big barrier to incorporation.

Capital Gains Tax

Let’s say that 10 years ago, you purchased one of your properties for exactly £150k.  Before you sell it on to the company, you’ll have to get it valued.  You’re surprised to see that the property value has doubled to £300k.  Sadly though, if you sell the property to your company, you’re going to have to pay tax on that £150k gain you’ve just made, although you may be able to take advantage of the various CGT reliefs and exemptions.

For some landlords, it might be possible to take advantage of incorporation relief, although this is extremely difficult for a large percentage of landlords. This enables a business to be transferred to a company without triggering a CGT charge, so long as the transfer of net assets is wholly in exchange for shares. There is, as you know, uncertainty as to whether simply owning rental properties amounts to a ‘business’. HMRC no longer provide clearance and, at some point, they may make the challenge. The property activities must provide the majority of your income, so you should have no other occupation or significant income source. The landlord must be actively managing the properties, spending around 20+ hours per week in doing so. The property business should be run to make a profit, with a ‘substantial’ turnover’. You should have tenant management systems, banking arrangements and using ‘sound, recognised business principles’.  So as you see, this is not typical for a large percentage of landlords

CGT can also be avoided if the property business is run as a partnership before incorporating. An added bonus is that if a property partnership incorporation exists, you are able to gain relief of up to 100% of the SDLT charge. Broadly, full relief from SDLT is given as long as the ownership of the new company matches the original partnership shares.  However, this has to be a genuine partnership. Just being a husband and wife with a few properties does not automatically mean you are a partnership.  You and your solicitor need to ensure that the partnership agreement and arrangement is watertight to ensure it does not fall into HMRC’s definition of a “fake partnership” with the sole object of avoiding tax.

You will need a proper written partnership agreement, as well as a separate bank account for the partnership. You’ll obviously need to have the partnership registered with HMRC too. This alone is a fair bit of extra admin; it also means waiting a while before you can incorporate. You’ll first have to move your properties which you wish to incorporate into a partnership of at least two members.  As above, the partnership has to be a commercial business; you can’t just set up a partnership for a few days, incorporate it and expect to be clear of the taxman. This is a slow process. You will need to submit 3 years’ worth of self-assessments for the partners, as well as three years of partnership accounts. Once these have been produced, it is possible to incorporate the property business into a company.  This means that a genuine property partnership incorporation can be made with no immediate charge to tax, preventing the changes to the taxation of buy-to-let properties from making a significant impact, whilst enjoying the benefits of a limited company.

How much will I save incorporating?

There is no easy answer to this; it varies from person to person.  The key is to think long-term. For a lucky young professional who might benefit from the company for another 30-40 years, the total savings could be huge. For those nearing retirement age, it won’t be as significant, although it may still be worthwhile for Inheritance Tax purposes.

What we can tell you is that:

1. This tax saving can make it easier to grow your property portfolio. If you’re paying higher-rate tax at 40% (or more!) on top of National Insurance Contributions, the 19% corporation tax rate increases the amount of profit which you are able to re-invest in your portfolio.
2. You also get full tax relief on any mortgage interest costs. This can further reduce your tax liability, again helping you to grow your property portfolio in the long term.
3. By gifting family members shares annually to use up allowances, you are able to begin the process of shielding your portfolio from inheritance tax.
4. You gain the benefit of limited liability. In the event of a disaster, you are only liable for your initial share capital upon incorporation of the company. If a tenant were to take legal action, to claim compensation for whatever reason, this would limit your personal exposure to risk.

Summary

We’re sure you can see now that incorporation is something you have to take your time with. While it can be extremely beneficial, it will take a while to reap these benefits. It’s a slow process, best suited - though not exclusively - to those with high income, more than one or two properties, and (perhaps most importantly) the ability to think long-term. But each case is different and one should always consult with professional tax advisers experienced in property incorporation, such as ourselves at Rita4Rent. With so many variables and tax implications to consider, a poorly thought through strategy could end in a potentially ruinous tax bill and legal challenge from HMRC.  Always remember, you should be making the right decisions for the right reasons.