Insights

Article updated: 10th September 2019

The ability to build a residential rental property portfolio, whilst offsetting borrowing costs against rental income, has historically made buy to let a very popular investment. This has been especially true for higher rate taxpayers, who have been able to claim tax relief at their marginal rates.

However, recent policy changes have meant that the tax relief available has now been eroded, with the gradual removal of mortgage interest tax relief. This began in April 2017 and by the 2020-2021 tax year, only basic the rate of tax relief will be available for borrowing costs for all taxpayers.

Tax rates: How is tax relief on buy-to-let mortgage interest calculated?

This timeline illustrates how tax relief on mortgage borrowings has been reduced:

• 2017 – 2018: Deduction from property income restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction;
• 2018 – 2019: 50% finance costs deduction and 50% given as a basic rate tax reduction;
• 2019 – 2020: 25% finance costs deduction and 75% given as a basic rate tax reduction;
• 2020 – 2021: all finance costs incurred by a residential landlord will be given as a basic rate tax reduction.

Investing in property through a company

These reductions, together with the additional stamp duty land tax (SDLT) surcharges, removal of the former ‘wear and tear’ allowance and higher rates of capital gains tax applying to disposals of residential property investments, has created a surge among taxpayers looking for ways to mitigate the tax increases. One of these has been to incorporate properties into a company structure.

Investing in property through a limited company is one obvious alternative to personal investment, but this needs careful evaluation as it has its own set of pros and cons. One big issue is that commercial interest rates, which are charged on mortgages involving company owned property, can be significantly higher than the low headline rates currently available to individuals on the high street.

In an attempt to avoid this issue, some landlords are turning to an alternative option, with a ‘Beneficial Interest Company Trust’, a special structure designed to allow the property investor to potentially ‘have their cake and eat it’.

What is a Beneficial Interest Company Trust?

A Beneficial Interest Company Trust works by allowing the landlord to move the economic value of their property into a company, whilst retaining the legal title of the property and thus the mortgage, in their personal name. By owning the property through a structure such as a Beneficial Interest Company Trust, the landlord is able to obtain a personal mortgage on the property and benefit from the lower interest rates, but, from a tax perspective, still treat the property as if it was part of the company. Rental income is paid to the company and the landlord accesses this through a combination of salary and dividends. This means they are not impacted by the erosion of tax relief on mortgage interest or any of the other more punitive tax policies.

Are there downsides to using a beneficial interest company trust?

The beneficial interest company trust structure was originally reported in 2017 and has created quite a lot of debate within the tax profession ever since, with suggestions of potential mortgage fraud, mis-match of income and mortgage interest relief, and likely attacks from HMRC on the basis that such a move is tax motivated rather than commercially motivated, therefore is subject to anti-avoidance legislation. Now a few years on, it remains controversial. There are no guarantees that HMRC will not in the future classify tax planning arrangements like the beneficial interest company trust as a tax avoidance measure and pursue what they regard as outstanding tax liabilities retrospectively. Having one in place may also impact future ability to secure a mortgage with a lender.

How to evaluate putting rental property into limited company

Whatever your views, any consideration of the transfer of residential property to a limited company should also include a review of the following issues:

1. Stamp duty land tax (SDLT) applies to the transfer of residential property from an individual to a limited company. In some cases, tax planning can reduce or mitigate this, but it is a complex planning area and is not suitable for all cases;

1. Capital gains tax (CGT) will apply to the transfer if the value of the property has increased since it was purchased. Again, tax planning can apply to reduce the tax in certain cases. If relief is not available, the rate of CGT applying is 28%;

1. Where residential property is owned by a company, the annual tax on enveloped dwellings (ATED) needs to be considered. Relief may be available from this tax if the property is rented to unconnected parties, however there is still likely to be a reporting issue;
2. For more information about ATED deadlines for rental property owners read our earlier article: https://rjp.co.uk/2017/04/25/important-ated-deadlines-rental-property-owners/

If it is not commercially feasible to transfer an existing property portfolio due to the costs involved, an alternative approach may be to continue with personal ownership of existing property investments and consider the pros and cons of investing through a limited company for any new acquisitions. The downside of this approach is likely to be the more costly mortgage interest rates and the fact that there are no guarantees that the tax position will not change in the future.

Many of RJP’s clients have property investments and we have helped many taxpayers with very tailored tax advice to mitigate their property tax issues. If you would like to get in touch with questions, please email partners@rjp.co.uk.