In recent months the number of enquiries regarding what to do with property investment portfolios has increased markedly. There is no doubt one of the main reasons for this is the gradual phasing out of income tax relief for loan interest and other finance costs on residential/buy-to-let properties.
Until April 2017, taxpayers obtained relief for interest and other finance costs at their marginal rate of tax – for example 40% relief if a higher rate taxpayer etc.
After April 2021, tax relief will have been restricted for all taxpayers to 20% of the lower of:-
- The interest/finance costs
- The profits of the property business, or
- The total income that exceeds the personal allowance in the tax year.
In the worst-case scenario, an individual could end up paying tax despite making a real loss on a property portfolio.
Between April 2017 and April 2021, the change is being phased in gradually.
With current income tax rates ranging from 10% to 45% (46% if you live in Scotland), and corporation tax charged at a flat rate of 19%, the simple answer may appear to be to incorporate the property business.
That certainly carries some very attractive advantages
- The company gets full tax relief on loan interest/finance costs
- The profit is taxed at a flat rate of 19%
- You can choose to accumulate profits and/or when to distribute them by way of dividend
- There is the possibility of bringing other family members into the company as shareholders – though beware of the settlement provisions;
- Banks often prefer to lend to a company
- The property is ringfenced in a company so that in the event of a claim by a tenant or other 3rd party, liability is ringfenced within the company
- It is easier to undertake inheritance tax planning when dealing with shares as opposed to direct interests in property
However whether or not to incorporate depends not just on the advantages but on several other key factors as well, including:-
- Long-term plans for the property/properties
- Whether you can obtain capital gains tax relief on incorporating
- The cost of Land & Buildings Transaction Tax (or Stamp Duty in England/Wales/Northern Ireland) on transferring the properties into the company
- The existing (potentially cheap?) cost of borrowing versus new borrowing taken on by the limited company
- On a sale of the property by the company, the potential exposure to double taxation – corporation tax on the gain on sale, and then income tax on distributing the profit of sale to the shareholder(s).
In short, there is no hard and fast rule on what to do; given the complex issues, each individual case needs to be judged on its own merits, having regard to the commercial points as well as the financial ones.
Even if you intend to do nothing, you should at least take advice on the increased tax cost, which is already materializing during this 4 year transition period.
It may well be worth incurring some short term pain in order to reorder your property investments for much longer term gain.
Perhaps the bigger picture is that rents are being pushed up to cover tax and regulatory pressures, but that’s another article to follow…