Step by step guide to incorporating a property investment business using a property partnership
The restriction on mortgage interest relief has made limited companies more attractive vehicles for property ownership as the relief for mortgage interest is not restricted for corporation tax purposes. In addition, the rate of tax charged on profits is lower and succession planning is simpler.
Transferring properties into a limited company will normally trigger capital gains tax (CGT) and SDLT, but CGT can be avoided if the scale and character of property investment is sufficient to allow the portfolio to be treated as a business. If this is the case, incorporation relief can postpone tax on any increase in property values prior to the date of incorporation until the shares in the incorporated business are sold.
Due to the lower tax on profits enjoyed by companies, greater reinvestment of profits is possible in order to reduce mortgages and grow the business, and although further tax arises when funds are extracted from the business (usually as dividends), the overall tax paid on those profits should not exceed the tax currently paid by an individual or partner, even with the recently increased tax rates on dividends.
By incorporating your property business you would be able to:
However, Stamp Duty Land Tax is normally chargeable on the incorporation of a property business, based on the market value of the portfolio being transferred into the new company. Now that this charge would include the 3% surcharge, there appears to be a significant barrier to incorporation of a property business, but this is not the case for property businesses that are run as partnerships.
Incorporation
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
As the 2013 Ramsay case showed, you can mitigate CGT provided you can demonstrate that:
If you can demonstrate the above then you can claim incorporation relief, which means that you pay no CGT.
Stamp duty land tax and the Property Partnership
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 but 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.
If a property partnership incorporation exists, i.e. the partnership is registered with HMRC, has a written partnership agreement, separate bank account etc, or the properties are within a Limited Liability Partnership (LLP), relief of up to 100% of the SDLT charge is available. Broadly, full relief from SDLT is given as long as the ownership of the new company matches the original partnership shares.
This means that a genuine property partnership incorporation can be made with no immediate charge to tax and prevent the changes to the taxation of buy-to-let properties from making a significant impact, whilst enjoying the benefits of a limited company.
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:
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.