Mortgage interest relief is now restricted for individuals holding loans to acquire residential properties. Consequently, many people are considering holding their properties in a company where the restrictions do not apply. This has a number of advantages over holding the property personally.
Firstly, the company will only pay corporation tax on its net rents. The rate of corporation tax is 19% (17% from 2020) which contrasts with the income tax rate for individuals which can be as high as 45%. However, one needs to remember that there will also usually be an income tax charge where funds are distributed from a company. So, a company works best where the owner does not need to draw on the profits made.
Secondly, when the company sells a residential investment property it usually pays corporation tax on the gain at corporation tax rates and, in addition, in calculating the gain the cost is indexed for inflation. This contrasts with an individual who pays Capital Gains Tax (CGT) at 28% (18% for basic rate taxpayers) and does not receive indexation allowance. Again, though remember there is often a further tax charge in withdrawing funds from a company.
Thirdly, it is often possible for an individual to borrow from a bank and obtain tax relief at the full income tax rates (i.e. up to 45%) where it is to lend to his or her company to operate a property business. In contrast, the tax relief on the interest is restricted where the money is borrowed by an individual to purchase a residential property directly.
However, before you rush off and incorporate your existing property portfolios there are some potential tax charges. When you transfer your properties to the company there is a potential taxable chargeable gain. The gain is on the market value of the properties on the date of the transfer less what you paid for them and the rate of tax is 28% (18% for basic rate taxpayers).
There is a potential relief in the form of Incorporation Relief in which case no CGT charge arises. Incorporation Relief is available if, broadly, your business is transferred to your company in exchange for the issue of shares. This can apply to a transfer of a property business. However, HMRC generally will not accept that the passive holding of a few property investments represents a business and, the activity needs to be more substantial to constitute a business. We can consider all the relevant conditions with you.
In addition, on the transfer of the properties to the company, Stamp Duty Land Tax (SDLT) will be payable on the market value of the properties. A possible way around this is to transfer your properties firstly to a partnership or a Limited Liability Partnership. This operates the business for a few years and it can then usually, based on current legislation, transfer the properties to a company without SDLT.
If you would like to discuss this in more detail, please contact David Hadley or your usual Mercer & Hole contact.