Over the last few years, changes in the way that loan interest relief is given against rental income have increased effective tax rates for investors on their rental income: for example, raising rates from 45% to 57.5% for additional rate taxpayers. Many buy-to-let landlords have therefore considered operating their lettings through a company – ‘incorporating’ their property business.
For landlords who reinvest their rental profits within a company, the effective rate of tax is just 19%, however, even for those additional rate taxpayers who extract their profits through dividends, the effective rate should be 48.6% for 2020/21.
Of course, there are hurdles to moving your properties into a company structure: both stamp duty land tax (SDLT) and capital gains tax (CGT) can be triggered, so it is important to consider the issue carefully. However, the current reduced rates for SDLT (due to end on 31 March 2021), and the possibility of higher rates of CGT after the Budget, give a small window of opportunity for owners to act now.
Incorporation will normally trigger a CGT charge based on the market value of the properties, less their base cost (usually historic cost), unless incorporation relief is available to hold over the gain. Incorporation relief could potentially be available when transferring the activities to the company in exchange for shares; however, this is only where HMRC accepts that the letting is already being run ‘as a business’.
Alternatively, the properties could be sold to the company. While this may trigger an immediate CGT charge (payable within 30 days), it would create a loan account within the company, which could subsequently be drawn down tax-free. The current rates of CGT on UK residential property are 18% (basic rate taxpayers) and 28% (higher and additional rate taxpayers), but there is speculation that these rates may be equalised with income tax rates from Budget day or 6 April 2021.
The usual SDLT rates on residential property should apply on the transfer of the property, including the additional 3% charge where a company acquires a property. Given that current transfers of residential property in England valued at up to £500,000 are free of SDLT, many properties could be transferred to companies before 31 March, with just the 3% charge.
Striking the right balance
Of course, while a window of opportunity can be attractive, it is always important to consider your long term plans. If your properties are to be retained as a long term investment, then reducing the year-to-year tax on profits by incorporating the letting business is likely to be beneficial – even taking account of the up-front tax charges. If the capital tied up in the properties will be needed in the foreseeable future, or the properties put to other uses, incorporating and then extracting the properties after just a few years may not be cost-effective.
Don’t forget that any mortgage on the properties will need to either transfer or be refinanced, and the interest rates available to a company borrower may be higher - so a mortgage adviser should be consulted.
For help and advice on all tax issues related to investment and commercial properties, please get in touch with our team.
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