Changes to Mortgage Interest Relief came into effect in 2020 – a year on has much changed?
Landlords have been limited to income tax relief at the basic rate of 20%. They have seen a large increase in their taxable profits and a corresponding drop in ‘real’ profits.
Compounded by the removal of wear and tear allowances previously 10% of any rent receipts could be offset by this allowance.
Other Taxes have impacted to – 3% Additional Property Surcharge for Stamp Duty, differing rates for Capital Gains Tax 18% and 28% on property disposal, the watering down of relief against a former private residence giving rise to further CGT bills.
For larger portfolios – generally those of 5 or more properties there may be a solution.
For the purposes of this article let’s use a fictitious family – let me introduce you to Jean and Dave Smith-Jones. They’re in their 60s and have built up a handy property portfolio. The plan is to earn regular rental income through their retirement, before passing the portfolio on to their children, Lucy and Mike.
The question that’s bothering Jean and Dave relates to the legislation (outlined above). Can the impact of the increased liability be softened? And the answer? Potentially – yes!
Jean and Dave may need to incorporate their property portfolio. In other words, transfer it into a limited company – one that they’ve set up specifically for this purpose. This approach can yield several potential benefits.
- Jean and Dave will still receive the full benefit of Mortgage Interest Relief.
- They’ll retain profits in the company, thus avoiding unnecessary income tax.
- Expenses for property renovations & repairs are fully relievable against profits.
What about Stamp Duty (SDLT)? Will that still be payable?
The legislation around this is not straight forward and references to case law point the way forward.
For those clients operating via a partnership no SDLT should arise due to Schedule 15 FA 2003, so long as a number of conditions are met:
The partnership comprises family members.
The property must be held as partnership property.
The properties must not have been transferred into the partnership within the last 3 years.
Importantly, the treatment applies equally to Limited Liability Partnerships (LLPs) and it is possible for incorporation to occur only 12 months from the time that properties were transferred into the LLP, if the LLP is able to carry on some form of business for at least another 2 years.
How about Capital Gains Tax (CGT)?
There are circumstances under which Jean and Dave might benefit from ‘Holdover Relief’. In these cases, no CGT has to be paid on the transfer of the portfolio to the company. It only becomes due on the sale of the company shares.
So how do Jean and Dave obtain this Holdover Relief?
Case Law defines the way forward here to:
Elisabeth Moyne Ramsey v HMRC  & Incorporation Relief under s162 TCGA 1992 are the two principles that come into play for Jean & Dave, simply:
They need to satisfy certain criteria, based on proving that the portfolio is being run as a ‘business’
- How much time do Jean and Dave devote to working on the properties?
- Do they have any hands-on involvement in their maintenance or management?
- How large is the portfolio?
But what does this mean in real terms? As an example, and to keep things simple, let’s assume Jean & Dave brought 10 properties 10 years ago for £60,000 each and today the portfolio is now worth £1,200,000, not unrealistic for property values to double in that period.
They have owned the properties on a Tenants in Common basis each owning 50% of the portfolio with the rent paid to a specific bank account set up at outset and they both file their self-assessment tax returns annually declaring all the income and expenses. They retired when they purchased the properties, both regularly collect the rent as cash from their tenants and maintain any repairs themselves – very much a full-time job – “a business”.
The stamp Duty for transferring the portfolio to a company would be – £36,000
The Capital Gains Tax liability would be – £168,000
Or would it?
Providing all the criteria were met there would be no taxes to pay.
As for CGT the properties would benefit from an uplift under the Holdover regime and the values would be rebased at £1,200,000 for any tax calculations for the new company. Any properties sold would now be taxed at the smaller companies’ tax rate of 19%. Though Corporation Tax on gains above the £1.2m not £600,000 the original purchase price, as CGT only arises on sale or disposal of shares in the new company.
The position for Inheritance Tax though remains pretty much unchanged as the new company is not a Trading Company but an Investment Company it will still be taxable as part of Jean & Dave’s Estate – although with further planning and the next step in their tax planning strategy this too could be wholly mitigated.
It’s clear that incorporating their portfolio may well help Jean and Dave to legitimately avoid being penalised by the new legislation. However, there are a number of ‘ifs’ and ‘buts’ and each case needs to be assessed on its own as tax shouldn’t necessarily be the driver for making this type of decision.