Should I incorporate my property business?

In recent years, the benefits for private property investors have changed significantly. The introduction of higher rates of SDLT for additional residential property and withdrawal of mortgage interest relief has had a significant impact on the private property investor market.

Many individuals and business owners own residential property portfolios and are unsure whether to incorporate their property portfolio into a limited company. Incorporating a property portfolio can be more tax efficient depending on the size of the portfolio you own and your personal circumstances.

In this blog, I'll explore why you may consider incorporating a property portfolio and the tax advantages that you could gain from incorporation.

What does incorporation of a property business entail?

Transferring a property portfolio into a limited company involves transferring the ownership of the property to the incorporated entity.

You need to consider the following before doing this:

• Depending on the value of the buy-to-let properties, the company will need to pay Stamp Duty Land Tax (SDLT) on the value of the properties transferred - however it may be possible to reduce or even mitigate the SDLT payable with careful planning.

• If the buy-to-let properties have increased in value since you purchased them, the transfer into the limited company will give rise to a gain chargeable to Capital Gains Tax (CGT) payable at the point the transfer is made.

• You should seek professional advice on both corporate tax planning and personal tax planning before you decide to incorporate your property rental business.

• Property incorporation has tax benefits but can also cost you more in tax if you do not plan and structure it correctly.

• Before you decide to incorporate, discuss your thoughts with your mortgage providers. Fees may be incurred, or mortgage terms changed by your lender, so you need to understand the cost implications of this.

• Because the properties will be transferred at 'market value' into the limited company, you should obtain a professional valuation of the properties.

Why do property investors choose to incorporate?

Many property investors choose to incorporate to benefit from tax relief and tax savings. Incorporating buy-to-lets into a limited company is best suited to those with a high income, multiple properties, and the intention to hold them long-term with reinvestment of profit.

Advantages of property business incorporation

• If you own your property personally, you pay income tax on rental profits. However, if you put your rental property portfolio into a limited company you will pay corporation tax (currently between 19% and 25% depending on profits)

• One of the main advantages of incorporating a property rental business is that you can offset mortgage interest against the rental income before paying tax, which can save a significant amount of money over the term of a mortgage.

• Holding residential property within a limited company structure can provide a higher yield (net of tax) on the property portfolio due to corporation tax rates being significantly lower than higher and additional rate income tax rates.

• If you don't require all the income generated, then it can be utilised for future investment or accumulated to enable faster repayment of debt.

• Limited companies don’t need to pay capital gains tax, stamp duty or inheritance tax when transferring ownership of a property from one party to another. So, if you're looking to downsize your portfolio in the future you could keep more of the money from the transaction (minus corporation tax).

• The transfer of properties by an individual to a company will be a disposal for CGT purposes and will be deemed to take place at market value. However, provided the relevant criteria are met, there is a relief available on incorporation that enables the gain to be deferred and rolled into the base cost of the shares issued in exchange for the properties. Also, the base costs of the properties themselves are uplifted tax free to market value on transfer into the company, thereby reducing future CGT charges on a later disposal of those properties by the company.

• Limited companies are subject to limited liability, meaning your landlord finances are separated entirely from your other companies or personal finances, should anything go wrong with your property rental business.

• A property investment company can also be a useful tool for inheritance tax (IHT) planning, by enabling you to issue different classes of shares to family members. This entitles them to future increases in the capital value of the company. This won't reduce your own IHT position, but it does limit your IHT exposure so that the value of any future growth falls outside their estates.

   

Disadvantages of property business incorporation

• A limited company needs to file yearly accounts and annual tax returns, so there is increased administration and costs for the business.

• Money you take out of the business will still be subject to an income tax liability (depending on the amount you take from the business). However, you do have the option to take a proportion out as dividends.

• Buy-to-let mortgages are generally more expensive for limited companies as lenders perceive them to be higher risk.

• The main disadvantage to transferring property to a limited company is the risk of paying large one-off costs such as Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT). However, a common strategy is to take advantage of certain reliefs which may apply to mitigate the potential capital gains tax and stamp duty land tax liabilities. For example, taking advantage of incorporation relief (see below).

Incorporation relief

Incorporation Relief means you will not pay any tax until you sell or dispose of the properties. This may be available to use to offset the value of the gains from the sale of the properties against the cost of the shares exchanged for the properties in the newly incorporated company.

However, to benefit from this, the following conditions must be met:

A “Substantive” property business must exist. The term “Substantive” is not wholly defined but guidance shows that to qualify there must be a "reasonable amount of time spent on property-related activities."

This will affect individuals with just one two properties and even larger landlords may struggle to meet the criteria if they work full-time doing something else.

When should I incorporate my property business?

If and when you should incorporate your property business, will depend on your own personal circumstances and the size of your portfolio. However, it is worth seeking advice from an accountant such as Haines Watts to establish if incorporation will be a benefit to you.

Conclusion

The process of incorporating isn't straightforward before making the decision to incorporate you should seek professional tax advice.

If not planned and executed properly, incorporating could lead to significant tax charges including capital gains tax (CGT) and stamp duty land tax (SDLT). It is also important to bear in mind that mortgage interest rates may be higher for a limited company.

Individuals holding larger portfolios may qualify for relief from these taxes, but smaller landlords with only a small portfolio may not qualify. The initial cost of incorporation may be prohibitive for smaller landlords.

With other legal requirements being tightened for landlords, you need to carefully assess if you continue to rent out property and if you do, whether to incorporate or not.

Here at Haines Watts our tax team, can do a cost/benefit assessment to help you to decide if you should incorporate your property rental business. For help and advice, you can contact us at our offices in Liverpool, Wirral and Chester.