Residential Landlords

This article has been provided by Alan McCann (DTE) Head of Tax Dispute Resolution

Residential landlords – the squeeze on mortgage interest relief is now with us, so many clients will be asking ‘is Incorporation the answer’?

We are now ‘live’ in terms of the 6 April 2017 commencement of the restrictions on mortgage interest relief for residential landlords (Section 272A ITTOIA 200S), originally announced back in Budget 2015.

The first phase of these restrictions means that 25% of the interest costs in 2016/17 will only receive relief up to 20%. The relief restrictions will be fully in place for the 2020/21 tax year.

The mechanics of the restriction can also give rise to unexpected results. The restriction limits relief to the basic rate but because it operates by requiring the rental profits to be calculated without a deduction for interest costs, individuals who were regularly basic-rate taxpayers could find themselves paying tax at the higher rate (before applying the 20% tax reduction).

Is there an alternative?

There aren’t many weeks that go by where there is an article or feature that covers the plight of individual residential landlords, particularly in the light of the combined effects of changes to:

  • SDLT hikes on second properties
  • Mortgage interest relief restrictions
  • The growing gap between corporate and personal income tax rates

Not surprisingly, many landlords have been considering forming a limited company through which to run their property portfolio businesses. The use of italics wasn’t accidental. Advisors have keenly been monitoring the potential application of the decision in the Ramsay case (2013 UTT 0226) where it was ruled that the lettings activity constituted a business. The significance for landlords of such a ruling is the potential availability of Incorporation Relief (Section 162 TCGA 1992) which enables the capital gains, which would otherwise arise, calculated at open market value when transferring assets to a limited company, to be effectively rolled over into the base costs of the shares issued to them if a business exists.

If the case can be made that a business exists then the landlord can look forward to:

  • Full relief for any mortgage interest costs
  • A current corporation tax rate of 19%
  • A more flexible asset (shares) in the context of IHT planning both in terms of valuation mechanics (discounts for minority holdings) and divisibility compared to directly owned properties.

But…..

Life is never that simple. As with most client transactions care needs to be taken to ensure that the bigger picture is carefully reviewed, not least to ensure that consideration is given to:

SDLT will arise on incorporations from sole trades but will not arise on incorporations of a partnership lettings business.

VAT could arise albeit the transfer of most businesses would be within the Transfer of Going Concern (TOGC) rules that prevent charges arising.

Refinancing – it is never too early to start talking to your lender (and for many residential landlords this will be in the plural). If incorporation is being considered it is not uncommon for potential incorporations to come unstuck as a result of the costs involved in re-financing properties through the limited company.

Watch the level of borrowings -there has to be as a minimum sufficient net value in the business assets transferred to cover the rolled over capital gain (otherwise CGT will be payable on any excess).

IHT shouldn’t be an issue for business incorporations as the transferor is effectively swapping their direct ownerships in assets to an equivalent holding of shares in the limited company. If incorporation reliefs are not being sought then care should be exercised if the client is instead considering gifting properties to a limited company in situations where there is a difference between the property ownership structure and company shareholdings such that a loss to the donor’s estate could arise (on top of potential capital gains liabilities that could arise on such gifts).

Summary

Incorporation of a property business can potentially provide substantial savings for residential landlords but care needs to be taken to ensure that all aspects of the wider client position are taken into account.

DTE would be happy to help advise……

And finally….

HMRC have updated their online IHT calculator tool for the new Residential Nil Rate Band (RNRB)

Whilst we are looking at residential matters, the government, in their kindness, have updated their online IHT calculator to reflect the effect of the new residential nil rate band (which is now phased in over the next 4 years). However, a word of warning, HMRC also emphasise that the calculator is designed for simple estate calculations and warn that for instance if the estate includes assets where BPR and/or APR are due then this relief needs to be calculated before using the online tool.

The tool can be accessed here:

To read more regarding tax, fee protection schemes, VAT visit Resources

 

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