When should I incorporate my property portfolio?
The decision to hold property within a company depends on many factors. One important factor is whether it is commercially viable. For example, lenders often have different criteria when lending to a company than to an individual. If a portfolio is highly geared, it may be that the lenders would not finance the property portfolio if held within a company. If using a company is desired, it may also be prudent to consider adjusting (selling) the portfolio.
It is also sensible to consider whether it is appropriate to transfer a portfolio to a company, sell properties and place the proceeds in a company to invest or to simply start additional investments through a company.
There could also be a disposal for CGT purposes on incorporating giving rise to tax liabilities. Similarly, it may be possible to obtain incorporation relief if the portfolio is operated as a business. The definition of a business for tax purposes needs to be analysed carefully to see whether relief will be available. The potential tax cost of assuming relief is available on incorporation but then denied by HMRC could be substantially detrimental.
If you are a property investor who intends to maintain a portfolio for the long term and possibly pass the value onto future generations, a company structure would appear to be a valuable option. Very simply, drawing earnings from a company is not dissimilar in tax costs as owning directly although it can vary from year to year. Passing on shares in a company in a controlled manner is often easier and less costly than passing actual properties. It is possible to create different classes of shares with different rights and capital value thereby making them a flexible estate planning tool. The holding of shares by trustees can also be effective from an estate planning and tax perspective.
What are the tax implications of incorporating a property portfolio?
There is a disposal for CGT purposes, which may be relieved if the portfolio is operated as a business (incorporation relief).
There is a transfer for SDLT purposes although if a partnership transfers, the liability is reduced often to nil. Where there is borrowing attached to the properties when transferred, a liability to SDLT can arise on the value of the borrowings. It is possible to prevent a liability through clearing borrowing whilst incorporation proceeds (possibly by using a bridging facility).
A partnership (partnership or limited liability partnership) could be created and operated ahead of incorporation. If entering into a partnership with the intent to avoid SDLT on incorporation, HMRC may challenge the commerciality of transactions and challenge whether SDLT has been avoided. Where properties are held by spouses jointly, the position is often easier to achieve.
The new company will acquire the properties at market value (where the transfer is for consideration in shares). The incorporation will therefore effectively rebase the assets at their market value at the date of the transfer. Therefore, if the company subsequently disposes of any of the properties the chargeable gain will be substantially reduced.
What is incorporation relief?
The relief, known as incorporation relief, is available where a person:
- Transfers a business to a company as a going concern;
- Together with the whole assets of the business (except cash); and
- The assets are transferred wholly or partly in exchange for an issue of shares in the company.
Provided the consideration for the transfer of the assets and business is wholly in shares the gains arising on the transfer of the properties will be deducted from the deemed consideration given for the shares.
If HMRC were to challenge the applicability of this relief, it would be necessary to establish that the partnership was a business. This will require meticulous record keeping and personal management of all properties during the period in which the partnership owns the properties.
Substantive property letting activities can be treated as a business for the purposes of incorporation relief. However, each portfolio will need careful review to determine whether it meets the criteria established through case law that it is a business.
What are the tax risks associated with incorporating a portfolio?
Incorporating a property portfolio is not simple from a tax perspective and each case is different. The risk of getting it wrong include SDLT and CGT liabilities and well as late payment interest and the potential for penalties.
This summary is not intended to be advice in any one situation and if looking to incorporate you should seek specific tax advice.
Are there alternative methods to achieve a deduction for mortgage interest?
There are methods purported to result in an interest deduction although each carries risk of challenge resulting in the denial of the tax saving. You should be made aware of the risks ahead of entering into any arrangement. For example, some advisers suggest the properties may be held on trust for a company thereby alleviating the need to move finance arrangements. The ability to do this will depend on the specific terms of mortgages and care should be adopted. Other arrangements promoted include the use of a corporate partner within a limited liability partnership structure although complex anti avoidance legislation may apply to such arrangements and there may be several potential areas of challenge.