The best tax structure for landlords

The best tax structure for landlords very much depends on taxable income. For example, a couple who are earning say £30,000 each who plan to purchase two or three properties, where the combined rental profits and mortgage interest wouldn’t push them into the higher rate tax bands, might be better off with a partnership.

It is important to understand that whatever level you are now, and however you’re structured, it isn’t too late to make changes.

Remember that children above the age of 18 can also become partners in a property rental business if they have at least some involvement in the business. This in itself can be very advantageous from both an income tax and an inheritance tax perspective. This is because partnerships can allocate profits disproportionately to ownership. If the children have nil tax tax allowances (currently £11,850 a year each) which are unused they could be allocated income of that amount. Similarly, the children could also be allocated a further £34,450 a year of profits and pay just 20% tax. If the parents are paying tax at the higher rate it might make sense to reallocate profits to the children on the basis above.

Also remember that profits allocated do not need to be drawn, they can also be retained. Each partner has a capital account, much like a bank account in that partners can either be overdrawn or in credit. On that basis, parents might agree to allocate profits to the children on the understanding that the the children’s capital account will accumulate (save for any tax payable) whilst the parents capital accounts might even go overdrawn. This can be particularly useful for IHT planning, on the basis that upon death an overdrawn partnership capital account is considered to be a liability against the value of the the deceased partners estate.

As taxable income begins to stray into the higher rate tax bracket the partners will become affected by the section 24 restrictions on finance cost relief and 40% tax. Where this is the case, and the partnership also plan to retain rental profit to invest into further property acquisition, a mixed partnership can begin to make sense.

The mixed partnership strategy involves forming a Limited Company to manage the partnership properties and making that company a partner in thebusiness.

One of the main reasons for making the management a company partner is so that if the partners ever decide to incorporate their business at a later date it is easier to do so. This is because it counters any suggestion from HMRC that the business wouldn’t qualify for incorporation relief. If the company isn’t a partner HMRC might say that you don’t qualify for incorporation relief because you are not incorporating the ‘whole business’. They might also say you are not a business but rather passive investors on the basis that management is dealt with outside the partnership. This is quite unlikely given that HMRC’s manual PIM1020 says “A person will carry on a rental business even if they engage an agent to handle it for them. The person carries on the business through the agent” and we are unaware of HMRC having ever tested this argument at a Tax Tribunal. However, given the simplicity of the extra steps required to appoint a management company a partner and register that with HMRC it is logical to do so to mitigate that risk, no matter how small the risk might be considered to be in reality.

In a mixed partnership for rental property purposes the company partner can charge up to 15% of gross rental income for performing its management activity without falling foul of HMRC’s “Transfer of Income Streams” rules. This would reduce the available profit for allocation to invididual partners and hence the tax theymight otherwise pay at the higher or additional rates of personal taxation.

The company would pay tax on its profits at the 19% corporation tax rate (scheduled to reduce to 18% next year and 17% the year after). This is far lower than your personal tax rate as higher rate tax-payer. You would also be able to utilise your annual tax-free dividend allowance (currently £2,000 each) to draw money from the company if you need it. Any further profits in the company could be retained for further investment into the business and the company could also be utilised for further rental property acquisitions. Remember that companies are not affected by the restrictions on finance cost relief.

If partners taxable income is (or would be) in the higher rate tax bracket, even with the the mixed partnership strategy and appointed management partner taking 15% of gross rental income, it then makes sense to consider incorporation.

Remember that under certain condition property rental businesses can roll their capital gains into shares in a company they transfer their properties into. Also, that Stamp Duty relief exists for partnerships when they transfer their ‘whole business’ into a company. And finally, note that the BICT structure (or SISS in Scotland) enables the transfer of beneficial interest in the ‘whole business’ to a copay without the need to immediately refinance.

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