What are the recent changes to property taxation?
Restriction of relief for finance costs
Legislation was introduced in 2015 which restricts the amount that landlords may deduct in respect of finance costs when calculating the profits subject to income tax. The rules apply to trustees, personal representatives, and individuals. They do not currently apply to companies.
The restriction is phased in from 6 April 2017. By 6 April 2020 no relief will be available in the calculation of taxable profits. Instead, relief will be given by way of a basic rate (currently 20%) tax reducer. The tax reducer cannot create a repayment of tax, any unused amounts will be carried forward.
For the 2018/19 tax year 50% of finance costs can be deducted in the calculation of profits, the remaining 50% will be given as the tax reducer.
The tax reducer will be the lower of:
- Finance costs (including unrelieved amounts from prior years)
- Property income arising in the year (less brought forward property losses)
- The landlord’s adjusted net income (total income less personal allowance and gross personal pension contributions)
Stamp Duty Land Tax (SDLT)
From 1 April 2016 a higher rate a SDLT applies to the purchase of:
- Additional residential properties by an individual
- Residential properties by a company (although reliefs may be available)
Where the higher rate applies, the purchaser pays an additional 3% of SDLT of the value of the property.
Payment of Capital Gains Tax (CGT)
Individuals are currently required to report gains and pay CGT via their self-assessment tax return by 31 January following the tax year of disposal.
On 11 April 2018 the UK government published a consultation document which outlined proposals to make CGT arising from the disposal of residential property (both UK and overseas) payable within 30 days of completion.
Following conclusion of the consultation, the government confirmed that they will legislate to bring this change into effect from 6 April 2020.
Wear and Tear Allowance, and Replacement of Domestic Items Relief
Available only on furnished lettings, wear and tear allowance was given as a 10% deduction from rental income after disbursements.
From April 2016 this relief was abolished. Instead, landlords can claim a deduction for the cost of replacing existing furniture and appliances when they reach the end of their useful life. The replacement must be like-for-like and not constitute an improvement.
It should be noted that as a result of this change landlords may now claim a deduction for the cost of replacing carpets and white goods, which were previously excluded.
Annual Tax on Enveloped Dwellings (ATED)
The ATED applies to high value dwellings which are situated in the UK and owned by non-natural persons i.e. by a company, or by a partnership with a corporate partner. The rules came into effect from 1 April 2013 and currently applies to properties with a market value at 1 April 2017, or acquisition date if later, in excess of £500,000.
The date of acquisition will be the date the properties are transferred to or acquired by the company.
Where a company holds a dwelling within the scope of the ATED, it must submit an annual return to HMRC between 1 and 30 April in respect of the coming financial year.
There are a number of reliefs from the ATED regime, which includes reliefs for property developers and property rental businesses. A claim for the relief must be included in the company’s annual ATED return.
However, if a non-qualifying individual (anyone connected to the company or a relation of someone connected to the company) is permitted to occupy the property the relief will be disapplied.
Under the ATED regime properties are required to be valued every five years, the next relevant date being 1 April 2022.
It should be noted that when the ATED was introduced the threshold value was £2 million and has reduced to £500,00 from 2014. There are currently no published plans to reduce the threshold further.
Where the ATED regime applies, properties will be subject to:
- An SDLT rate of 15% in respect of the acquisition of the property by the company
- An annual flat rate tax based on the value of the property, payable by 30 April each year
- A CGT rate of 28% in respect of the disposal of the property by the company
Principal Primary Residence (PPR) Relief and Lettings Relief
The chancellor announced in the autumn budget that, from April 2020, PPR Relief on the final period of ownership will be reduced from 18 months to 9 months if the property is not occupied at the time of sale.
A further announcement related to the availability of Lettings Relief, which is available where a property has been the taxpayers PPR for a period of ownership. From April 2020 Lettings Relief will only be available if the landlord and tenant are in shared occupation.
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 valuable. 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 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.