Should I Transfer Individual Properties into a Company?First Published: September 2020 | Available in: Property Articles Your Property Network
Many landlords own mortgaged residential property in their personal name, & are affected by ‘section 24’ mortgage interest relief restrictions, & so ideally would like to transfer individual properties into a property company, to avoid Section 24. However the CGT & SDLT cost of doing this is often prohibitive… but not always!
Why should I consider transferring my personally-owned properties into my property company?
Many residential landlords now own a property portfolio that is split between personal and company ownership – certainly those who where landlords before July 2015 when the then-Chancellor George Osbourne announced ‘Section 24’ mortgage interest restrictions would begin from tax year 2018, phasing in over the 2018, 2019, 2020, 2021 tax years, replacing a direct tax deduction for residential finance costs with a flat-rate tax credit on 20%.
This can mean that mortgaged personally-owned residential property can be subject to high rates of taxation, & so there is an incentive to transfer such property into a company, where Section 24 doesn’t apply.
Mrs Miggins is employed on a salary of £60k, & so is a Higher Rate (40%) taxpayer. She owns 3 residential properties on Pie Shop Lane in her personal name. Each Pie Shop Lane property is valued at £125k, yields a net rent (after repairs and insurance) of £500pcm, & has a mortgage costing £250 pcm.
From tax year 2021 onwards, Mrs Miggins will pay annual income tax of £1,800 on each Pie Shop Lane property, using these figures, a marginal tax rate of 60% on cash profit.
What’s the issue when transferring residential property into my property company then?
Using a property company for new acquisitions has made tax sense for many landlords since Section 24, as finance costs remain fully-deductible in a company.
However the key issue with transferring existing personally-owned residential property into a company is that for tax purposes the landlord and the company are treated as ‘connected’, and so properties are deemed to be transferred at market value for tax purposes
Often the capital gain on a property transferring to a company is either nil or modest, often because there may not be a capital gain as such (many areas of the UK have not seen house price growth for a decade), or because the CGT Annual Exemption (x2 for joint property owners) covers the gain, or because the landlord has capital losses to utilise.
Companies acquiring residential property are subject to a 3% SDLT surcharge, which can make a property transfer into a company a prohibitively expensive option.
However, there are some SDLT-mitigating options that may reduce the SDLT cost to an ‘acceptable’ (as far as paying SDLT can ever be ‘acceptable’!) level:
- Government has reduced the SDLT charge on properties purchased by (or transferred into) a company to a flat-rate of 3%, up to a value of £500k. This change began on 8.7.20 and lasts until 31.3.21, and has much-reduced the SDLT due on many properties (e.g. a £500k property transfer to a company would now cost £15k, rather than £30k)
- Multiple Dwelling relief (MDR) – where 2 or more properties are transferred, the average value of the properties can be used for SDLT purposes, which can sometimes lead to a lower overall SDLT bill
- When 6 or more properties are transferred to a company, the non-residential rates of SDLT apply, which means the 3% SDLT residential surcharge doesn’t apply.
So, what are the benefits of transferring residential property into my property company?
1. Reducing personal income tax by avoiding Section 24 mortgage interest restrictions
Mrs Miggins’ Pie Shop Lane property above would be taxed at £570 in a company (@19% corporation tax rate), a reduction of about a third of the personal income tax cost (the marginal tax rate for personal ownership was 60%).
If Mrs Miggins had a credit on her company Director’s Loan Account, she could extract the post-tax profit from the company tax-free. Or she could retain the funds in the company and save it towards a new property deposit, pay into a company pension, pay down company mortgages etc.
2. Property equity is credited to the Director’s Loan Account
This is potentially where a Higher Rate taxpayer can get a major tax benefit. When a property is transferred from personal to company ownership, the equity is treated as a credit to the Director’s Loan Account, which in turn allows the Director to extract that amount from the company tax-free.
If Mrs Miggins’ Pie Shop Lane property were mortgage-free, the full £125k value would be credited to her Directors Loan Account. As Mrs Miggins is a Higher Rate taxpayer, this means that she would not need to pay the 32.5% income tax rate that would otherwise apply, because she now has a £125k credit on her Directors Loan account. This then could potentially save her 32.5% x £125k = £40,625 in income tax if you wanted to extract the company’s profits for personal spending.
Even if the property were mortgaged, the equity would still be credited to the Directors Loan Account e.g. a 60% company mortgage would mean that 40% of the £125k property value (£50k) would be credited to the Director’s Loan Account.
For Higher Rate taxpayers wishing to access their property company’s profits but without incurring personal Higher Rate income tax to do so, this is an extremely valuable benefit.
3. Property profits taxed at corporation tax rate (19% as at August 2020)
A key benefit of company property ownership is that there is a flat corporation tax rate, as opposed to a tiered income tax regime, and residential finance costs are fully-deductible. This therefore allows a property company to have a much-larger portfolio size compared to personal property ownership, while still benefitting from a flat, low tax rate.
So, how do I decide whether it’s worth transferring a property into my company?
- Establish the market value of the property in question – bear in mind, if using a company mortgage to facilitate the transfer from personal to company, the lender’s surveyor will, effectively, set the valuation of the property
- Calculate the SDLT that would be payable on the transfer of the property into a company – bearing in mind the temporary SDLT rate reduction, and the option to use Multiple Dwellings relief (2 or more properties transferred) or non-residential SDLT rates (6 or more properties transferred). Add the cost of any CGT payable
- Calculate the annual tax saved by having the property within a company i.e. compare the personal tax annual bill to a company tax annual bill = the annual saving. Then, consider the overall benefit of transferring the property into the company – e.g.Annual Tax Saved (personal income tax rate vs company tax rate) e.g. For Mrs Miggins’ Pie Shop Lane property, this was £1,800 – £570 = £1,230
SDLT cost: £3,750 (£125k @3%)
Payback Period: 3.3 years
(As a general guide, the ideal Payback Period should ideally by 2-5 years, to justify incurring tax now, to save tax in the future)
- Finally, factor in the benefit of a substantial credit on the Director’s Loan Account e.g. For Mrs Miggins’ mortgage-free Pie Shop Lane property, valued at £125k, there would be the benefit of being able take £125k of profits from the company without suffering a 32.5% income tax charge
- Finally, make a decision! Usually the most suitable properties to transfer into a company on an individual basis are those of modest value (since SDLT is lowest for lower value properties), and that aren’t standing a significant capital gain (so CGT on transfer is nil, or low), and that are ‘keepers’ i.e. good, solid rental properties that are worth retaining for the long-term, to make the transfer cost worth incurring.
Transferring individual personally-owned properties into a company incurs potentially CGT, and certainly SDLT. However it may well be the case that some upfront tax cost to move personal properties into a company can be worth incurring, to save rental profits from being taxed at high marginal tax rates as a result of Section 24.
And, there is the benefit of a credit to the Director’s Loan Account, which can save 32.5% dividend tax for a Higher Rate taxpayer, and be a useful way for Higher Rate taxpayers to access their property company’s profits without paying the punitive 32.5% Higher Rate of dividend tax.
Many property investors have cheap tracker mortgages that they would have to replace with more expensive company mortgages if they transferred a property to a company – and so a full incorporation (transferring ALL personally-held property into a company) isn’t an ideal option.
However that doesn’t mean that there isn’t a benefit in cherry-picking individual properties that are long-term keepers, with modest CGT & SDLT due on transfer to a company, which can result in a substantial overall tax saving when factoring in income tax saved and the credit added to the Director’s Loan Account within the company.