By now many individual landlords will be “feeling the pain” of the new income tax rules which restrict the deduction of loan interest costs against rental income from residential properties in favour of relief being given as a “tax reducer” equivalent to 20% of the finance costs.
This change has been phased in over a four year period beginning on 6 April 2017 and ending with the tax year beginning on 6 April 2020. For that tax year the applicable finance costs will get relief at an overall maximum rate of 20%, even for higher and additional rate taxpayers.
For the current tax year (ended 5 April 2020) three-quarters of the finance costs get relief that way, although because of the self-assessment system individuals won’t necessarily see the increased income tax bills until much later this year. For the returns that were filed on or before 31 January 2020, which covered the tax year ended 5 April 2019, 50% of the finance costs were still being given relief by way of a deduction against the rental profits, as opposed to a basic rate tax reducer.
Therefore, for many it will be now that the reality of the situation is starting to hit home, and the alternatives should be considered.
The tax changes are so drastic that they will compromise the business models for a number of buy to let investors because for those with significant borrowings in their portfolio the attributable income tax liabilities can and will end up exceeding the profit before tax.
Given that there is currently no similar restriction to interest deductibility for corporate entities, a number of investors have considered, and are in the process, of incorporating their property letting portfolio, i.e. transferring the property business to a Company which they own the shares in.
Doing so has a number of tax, legal and financial considerations which must be considered and fully understood before proceeding, however for the right type of landlord this may be a good solution.
Broadly speaking, the ideal candidates are higher or additional rate taxpayer landlords with several buy to let properties and sizeable borrowings against the portfolio. The landlords would be looking to invest for the long term and not necessarily requiring use of the rental profits every year.
Alternatively they may have a recently acquired portfolio that is not standing at too much of a gain such that the equity in the properties can be converted into money owed to the landlord by the limited company, and lead to an income tax-free extraction of cash in the future.
In either case the tax shield provided by a Company, i.e. lower rates of tax (19% currently and potentially reducing to 17% in April 2020) and full deductibility for mortgage interest, provide for a compelling case to consider incorporation.
However, the transfer of the portfolio potentially creates a charge to Capital Gains Tax (CGT) and a charge to Stamp Duty Land Tax (SDLT). The CGT charge can potentially be deferred if the portfolio is managed by the landlords and constitutes a business in its own right. Likewise, the SDLT can potentially be mitigated if the rental business is being run as a partnership. Alternatively, it may be that reliefs can be made to reduce the SDLT to a more affordable level.
The financing position will need to be reviewed carefully and liaison between the lender and the tax adviser should take place to ensure that the debt is restructured in the most tax efficient manner.
It is quite likely that 2020 will be the year for property business incorporations. No action should be taken without seeking professional advice relevant to your specific circumstances, and to discuss the pros and cons in more detail, our advisers, who are experienced in considering these issues and assisting with the necessary steps in order to re-organise a property business, are here to help. Please contact James Boustead, Tax Associate, at firstname.lastname@example.org or on 01245 254221 for more information
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