Beware of property rental tax planning schemes

It is never wise to make financial decisions based purely on tax implications. Tax legislation changes and whilst tax planning when making investments is prudent, it’s not the ‘be all and end all’. Property investments are one area where many taxpayers will have made decisions about the way property should be owned in order to mitigate tax, only to be wrong footed by subsequent events or changes to tax legislation.

A current example of where this might prove to be the case is individuals transferring privately owned property portfolios into the ownership of a limited company on the basis that it will be more tax efficient in capturing tax relief on interest payments. Now that only basic rate tax relief is available to offset against mortgage interest costs this is often especially the case if a property owner has a large amount of mortgage debt to consider.

Why transfer rental property to a company?

Many landlords have large mortgages to finance their property rental portfolios. Since the rules regarding claiming tax relief on finance costs were changed for residential properties (but not holiday lets) which are personally owned, some landlords have incorporated their property businesses. A company pays corporation tax on rental profits at the rate of 25% and receives tax relief on loan interest at the rate of 25% also. This is in comparison to individual landlords who are taxed on rental profits at income tax rates of up to 45% whilst receiving relief on mortgage interest at the rate of only 20%.

The transfer of one or two rental properties to a limited company will give rise to charges to capital gains tax (CGT) and stamp duty land tax (SDLT), but on the transfer of genuine property rental businesses which incur a significant amount of management time, reliefs are available.

This can prove extremely tax efficient for property owners who wish to use profits to repay borrowings in a shorter timescale because higher net profits will be available to do so. There are also benefits when the company disposes of property.

It is however important not to forget the mortgage lender – many lenders will not allow an existing personal mortgage to be transferred to a limited company and a new loan may be required, with the attendant costs and potentially higher interest rates. Some schemes are available that enable landlords to complete on a property business transfer to a limited company, whilst not registering the transaction at Land Registry, essentially in order to avoid the lender becoming aware of the transfer of ownership. This sounds very much like fraud to us!

When considering the benefits of a property transfer, what must also be borne in mind is the additional tax cost involved in extracting profits from a company – this will need to be done by way of dividend or salary, incurring additional tax liabilities for the shareholders.

In addition, the ATED tax charge is levied where the value of an individual residential property is £500,000 or more when it is transferred to the company, and on certain revaluation dates. Whilst there may be an exemption from the charge, the company is required to make an annual ATED return.

Our advice to any landlord who is considering incorporating their property portfolio is to seek tax advice from a CIOT (Chartered Institute of Taxation) qualified tax advisor.

If you own residential property rental and need to make improvements, many of these costs are fully tax deductible as an expense. Our article highlights the allowable expenditure that landlords can claim for repairs and maintenance: https://rjp.co.uk/clarifying-allowable-expenses-btl-landlords-can-claim-income/

If you would like advice on property tax, RJP LLP are CIOT approved and can be contacted via partners@rjp.co.uk.