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Property investors: Is now the right time to restructure?

Rob Sherwood, Manager, Private Clients
03/11/2020
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There is currently a renewed focus on the property market, especially residential property as the pandemic coupled with the Stamp Duty Land Tax (SDLT) holiday has seen activity in the market increase. In addition, attention has started to turn to what tax changes might be seen in the future to help balance the government’s books following the increased spending to support the economy.

What this means for property investors

While possible Income Tax rises will affect the yield on investments for rental businesses, it has been widely discussed that we may well see increases to Capital Gains Tax (CGT) when the time comes for the Chancellor to recoup some of the recent outlays.

The current rates of CGT are:

    Basic rate taxpayer  Higher rate taxpayer 
  Commercial property   10%  20%
  Residential property  18%  28%

If for example the rates are changed so that gains are taxed at a taxpayer’s marginal rate of Income Tax, this could see an increase of up to 25% in the rate of tax payable on these gains for an additional rate taxpayer.

This combined with general market uncertainty and speculation that reliefs such as private residence relief might be reviewed could mean that now is a good time for property owners to review the efficiency and structure of their property interests.

Actions to take

Typically property investors holding their assets directly consider two options for restructuring; Trusts or companies. This largely depends on what they are trying to achieve. For many Income Tax savings and loan interest relief are fundamental, whereas for others Inheritance Tax (IHT) and estate planning are at the forefront of their minds.

  • Trusts - Those looking for control and IHT savings often consider a Trust first as typically they do not have CGT or SDLT issues on creation. However there are limits as to the value that can be settled without an IHT charge. The level of the nil rate band is currently £325,000 for each settlor so a couple could settle £650,000.
  • Companies - Many taxpayers choose to hold property interests within a company structure often referred to as a family investment company. There is no restriction on companies for loan interest and rental profits are taxed at corporation tax rates (currently 19%) rather than Income Tax rates (currently as high as 45%). Family members can become shareholders which can be efficient from an IHT perspective and control for the founder can be retained via the shareholders agreement, which means that a FIC can be a viable alternative to a Trust. That said there are disadvantages. The major hurdles for incorporating a property business can be the potential for upfront CGT and SDLT costs. Also, companies work best if profits are retained within the company or only distributed to shareholders taxed at lower rates. Distributions to higher rate taxpayers result in a high double tax charge and can remove some of the benefits.

The current SDLT holiday, which reduces the amount of SDLT payable for properties under £500,000 to 0% or 3% and the potential for an increase in CGT rates means that there is a currently a window of opportunity to consider this planning with a cheaper tax cost.

Example

Mr Henderson is an additional taxpayer who owns a £500,000 rental property, with £375,000 of attached debt. The property was acquired in 2016 for £450,000.

The property produces rental income after expenses (excluding loan interest) of £30,000. Loan interest is £15,000 per year.

It is assumed below that regardless of structure that Mr Henderson will retain all post tax profits to pay down the current level of borrowing.

Income
As an additional rate taxpayer, Mr Henderson would pay Income Tax at 45% being £10,500 per annum on the rental receipts, leaving just £4,500 net profit to pay down the borrowings. On the other hand a company would pay corporation tax at 19% of £2,850.Assuming profits were retained by the company this would leave £12,150 net profit to pay down the borrowing.

Capital Gains Tax
On the transfer of the property to the company, based on a gain of £50,000, the deduction of Mr Henderson’s annual exemption (£12,300) and current tax rates of 28%, a total CGT liability of £10,556 could arise. Assuming CGT rates increased in line with Income Tax this could increase to £16,965.

Stamp Duty Land Tax
Transferring the property to a connected company would currently result in £15,000 of SDLT. However this would increase to £30,000 from 1 April 2021 when the current SDLT Holiday comes to an end.

Summary
In the above scenario a £9,300 annual tax saving on the rental income could be made by transferring the rental property to a company (assuming all post corporation tax profits are retained by the company to reduce borrowings), however there are some upfront costs which would need to be considered. It is likely, though that these will increase in the near future therefore if this is part of your tax planning strategy you would benefit from doing this sooner rather than later.

  Before tax increases After tax increases
  Tax saving on income £9,300 £9,300
  Capital Gains Tax £10,556 £16,965
  Stamp Duty Land Tax £15,000 £30,000
  Tax breakeven point 2.75 years 5.05 years

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How can we help?

At Crowe we can help you with the following:

  • Calculating and reporting tax liabilities on the disposal of your property interests
  • Ensure all reliefs and deductions to which you are entitled to are claimed properly
  • Reviewing the correct structure for holding your property interests, and ensure these are consistent with your goals.
  • Reviewing the impact your property interests have on your Inheritance Tax position, and advising on succession planning.
  • Help restructure your property portfolio if applicable.
  • Family investment company structures.

For more information about the issues raised in this article or to discuss your individual circumstances, get in touch with your usual Crowe contact.

Contact us

Rebecca Durrant
Rebecca Durrant
Partner, National Head of Private Clients
Manchester