Key Tax Considerations for Incorporating Your Property Portfolio

Joe Brough looks at some important tax considerations of incorporating a property portfolio. 

For owners of a residential property business, operating the most efficient structure will be a key decision in helping them to manage risk, grow their portfolio and minimise their tax exposure.   

Basic position 

Property investment businesses lend themselves to several business structures, with owners having the freedom to operate their portfolios as individuals, or with other people as a jointly let business (or more rarely as a partnership), or through a limited company or a hybrid of these models as the business has grown and developed. 

The diverse range of size and scale of property businesses means that there is not a ‘one-size-fits-all’ solution for every taxpayer. Indeed, incorporating a property portfolio will result in different tax implications for each individual, so bespoke planning is needed to ensure there are no unforeseen consequences.    

One of the main drivers behind incorporation is to improve tax efficiency. Where the business is owned outside a company structure, and an individual’s total income exceeds £100,000, rental profits can be subject to income tax rates of up to 60%, whilst a company’s highest marginal rate of corporation tax is 26.5%. At the other end of the scale, a basic rate taxpayer would pay 20% income tax, with the lowest rate of corporation tax being 19%. 

Other than where profits are fully covered by the personal allowance, corporation tax rates are lower than for individuals, which makes incorporation an attractive proposition. In addition, company ownership allows for tax-efficient profit extraction via salary and dividends, pension payments as a business expense and limited liability to protect the property portfolio against personal claims.   

Profit extraction  

Based on the headline tax rates, the benefits of incorporation are clear to see. However, this is not the end of the tax tail. When deciding whether incorporation would be beneficial overall, we also need to consider how the company will use the rental profits, along with the applicable capital taxes. 

For example, if post-tax profits are to be paid out to the shareholders as dividends, this will incur tax charges on them as individuals at their marginal rate of tax. This will therefore erode the benefits of a company being taxed at lower rates. 

Example: Company and personal tax 

Sam is the 100% shareholder of a company which owns a single residential rental property that has no mortgage debt. The company pays tax at the lower profits rate of 19%, and all post-tax profits are paid out as dividends.  

The effective rate of tax on the rental profits for a basic, higher-rate and additional-rate taxpayer are as follows: 

As can be seen, where the company’s profits are paid out in full, the taxpayer will suffer a higher rate of tax than if they had owned the property personally. 

Interest relief 

The example above only shows a basic analysis of the tax effects, and in the real world there are likely to be other factors to take into consideration, which will affect the total tax payable.  

For example, if Sam had a mortgage debt on their property, they would not be able to claim tax relief for finance costs as a business expense. Instead, individuals receive relief via a reduction in their tax liability for the year equivalent to the total finance costs multiplied by the basic rate of income tax.  

A company, on the other hand, can generally deduct all finance costs in full as a non-trading loan relationship debit and so is not subject to any restrictions on deductibility. 

Therefore, for higher rate and additional rate taxpayers, where finance costs are incurred, the effective tax charge on rental profits is higher when the properties are held personally. Additionally, as companies have lower tax rates, post-tax profits can be retained and used to speed up the repayment of debts or reinvest into other property.   

Capital taxes on incorporation 

If incorporation is decided to be beneficial from an income tax perspective, consideration will turn to how the properties are transferred. Unfortunately, it is not as simple as just channelling the income and expenses through the company without moving the underlying assets. Any attempt to do this is likely to be caught by the ‘settlements’ anti-avoidance legislation and will be ineffective for tax purposes. 

If a property business is just starting out, the process is simpler as the properties can be purchased straight away by the company. However, if there is an existing personal portfolio, capital gains tax will need to be considered. 

Capital gains tax 

The sale of a property to the company will need to be made at market value. As a startup company will not have any proceeds with which to pay the vendor, the disposal proceeds will likely remain outstanding on a loan account, which can then be withdrawn by the vendor tax-free as and when funds allow. 

If a taxable gain is made on the disposal, this will be taxable at either 18% or 24%, depending on the individual vendor’s total income for the tax year. This will result in a ‘dry’ tax charge, which must be reported and paid to HMRC within 60 days of completion, so it must be planned for. 

Any attempt to sell the properties for less than market value will clearly be a sale at undervalue and so caught by TCGA 1992, s 17, which will result in market value being substituted as deemed proceeds.  

In certain circumstances, where consideration for a disposal is received in instalments, an application can be made to HMRC (under TCGA 1992, s 280) for the tax to be paid over a period of up to ten years. However, this is by no means certain to be granted by HMRC and will be subject to stringent conditions, if allowed. 

Incorporation relief 

As an alternative to selling the properties and leaving the proceeds outstanding, an individual may instead choose to receive their disposal consideration in the form of shares, with incorporation relief under TCGA 1992, s 162 generally being available to defer capital gains. 

Incorporation relief is an automatic relief which does not have to be claimed if all the following qualifying conditions are met, although it can be disclaimed under TCGA 1992, s 162A: 

• All business assets, except cash, are transferred to the company; 

• Consideration is received wholly or partly in exchange for shares; 

• The business is transferred as a going concern. 

For a property portfolio to qualify for incorporation relief, the letting activities must be enough to constitute a business. In Ramsay v Revenue and Customs [2013] UKUT 226 (TCC), Mrs Ramsay was found to have spent 20 hours or more on letting activities each week, which was considered enough for incorporation relief to be available.  

Where incorporation relief is used, any gains are rolled over against the base cost of the shares, with the base cost of the properties in the company being equal to their market value at the date of transfer.  

For an individual adding to or disposing of properties from their portfolio, this effective rebasing can prove very useful as on a disposal of a property by the company, the chargeable gain will be lower than if the property had been sold personally.  

Stamp duty land tax 

On incorporation, a company is deemed to pay market value for the properties, irrespective of actual consideration paid (FA 2003, s 53). This will mean where properties are transferred to a company either via a sale with the proceeds left outstanding on a director’s loan account or via incorporation relief, a stamp duty land tax (SDLT) charge will arise (NB different taxes apply in Scotland and Wales).   

However, no SDLT charge is payable where the market value of a property transferred is below £40,000, or where the partnership is incorporated (although the anti-avoidance provisions in FA 2003, s 75A must be considered). Where SDLT is chargeable, each property will be subject to an additional SDLT surcharge of 5%, which will further increase the costs of incorporation. 

Practical tip 

When considering incorporation, ensure that both the long and short-term tax implications are considered. Whereas there may be income tax savings on the rental profits, where there is an existing portfolio, capital taxes may need to be paid to establish the new structure.