How we restructured to become debt free and super tax efficient

On paper, my spouse and I were worth £3,000,000 but the reality was that we had no savings, no money whatsoever to live on after paying our tax bills, and this was despite having rental income of £300,000 a year coming in. In fact, it was even worse than that, our tax bill exceeded our income by a very significant amount!

These were our numbers before we took action: –

Property portfolio value £6,000,000

Mortgage outstanding £3,000,000

Net equity £3,000,000

Capital gains £3,000,000

Rental income based on a 5% rental yield of £300,000

Mortgage interest based on a 6% interest rate of £180,000

Other costs of business £100,000

Profit £20,000

Two years ago our profits were £140,000 because we were only paying 2% interest rates.

We knew this would happen one day but to be honest we spent far too much time with our heads buried in the sand.

Now here’s the craziest thing, our income for tax purposes had not changed due to section 24.

Our taxable income remained the same at £200,000 a year. This was because we could not offset finance costs.

It doesn’t take a rocket scientist to work out that the tax on £200,000 a year is greater than the £20,000 of profits we were left with.

How were we supposed to live?

What could we do?

Our first idea was to sell half the properties and pay off all the mortgages. We factored in 3% for selling costs and lost rent, so £3,000,000 less 3% would leave us with £2,9010,000.

The problem we initially didn’t consider was Capital Gains Tax at 28% until we spoke to our Accountant.

He calculated that after factoring in selling costs, the capital gains we would have crystallised by selling 50% of our property rental portfolio would have been £1,410,000.

The tax on that would have cost us £394,800, so we would have been left with £1,015,200 to reduce our remaining mortgage balances of £1,500,000.

In other words, we could end up with a mortgage of £584,800 which would continue to cost us £35,088 a year (if interest rates had stayed as they were at 6%). As we know, interest rates are still going up.

We would still have had £150,000 of rental income coming in and by selling half of our properties our other costs would have halved too, so we would be looking at around £100,000 of taxable profit before finance costs of £35,088 a year. We felt we were getting somewhere because the outcome of all of this would have been real profits of £64,912 a year and our taxable income would have been calculated at £100,000, but we would still be skint, up to our necks in debt and remain exposed to interest rates going up even further. It was from a good feeling.

That’s when our Accountant introduced us to the Property118 tax team.

Step one of their recommendation was to form a Limited Company and then sell our entire rental property business to that company at the full market value of £6,000,000.

The consideration for tax purposes was £3,000,000 of shares and a further £3,000,000 indemnity for the debt.

No refinancing was required and we didn’t need to pay Capital Gains Tax or SDLT because we are a business Partnership by de-facto.

Property118’s fees for this were £6,000 and we had a further £13,000 of legal fees to pay. We borrowed money from Tesco Finance to pay those costs.

The capital gains still existed, but instead of being attached to our properties they were now attached to our shares and we had no plans to sell those.

We went on to sell just over 60% of our properties and didn’t have any CGT to pay whatsoever, because the values had not increased beyond what the company paid us for the properties. This meant that we had enough money left over to pay off all our mortgages and the Tesco Finance loan and still keep a chunk aside for a rainy day.

We are now completely mortgage free and I cannot begin to tell you how liberating that feels.

We are now making a reasonable profit, we pay ourselves a small salary to use up our personal allowances and that salary is deducted from our company profit for tax purposes. We also decided to pay our children a salary for the same purposes. They both go to University but will help us to redecorate our student-let properties in the Summer holidays. In the fullness of time, we are hopeful they will take over the business fully.

Here’s what our business looks like now: – 

Property values £2,400,000

Mortgage £nil

Cash at bank £450,000 (further peace of mind we didn’t previously have)

Rental income £120,000

Salaries £12,570 a year each X 4 (tax-free)

Other business costs at 33% of rental income £40,000

Profits retained annually in the business which are taxed at 19% = £30,000

The ability to do some extra work on the side if we choose to do so, without being pushed back into that horrible position of being higher rate taxpayers affected by Section 24 tax ever again!

Our longer-term plans are to go and live abroad somewhere. At that point we will no longer be UK tax residents, so we will not need to worry about CGT on our shares if we decide to sell them to our boys at that point. We will probably loan them the money to buy us out, which in reality will be a paper exercise. The company will pay us for those shares out of its future profits. We may well charge interest on that loan too, because that could reduce the profits for the business and HMRC will not tax us on that interest as non-residents. We will take further professional advice from Property118 if and when we do go down that route, but at the moment the prospects of moving to Dubai or Malta are becoming increasingly luring.

That said, if rents continue to go up, property values continue to go down and financing becomes viable again we might just be persuaded to dive back in again, leverage up our business and build our portfolio back up. Or perhaps that’s what the boys will do? Choices, choices, choices!

The bottom line is this, if you’re feeling trapped we highly recommend you book a tax planning consultation with the Property118 team. Their expertise and advice have quite literally been life-changing for us.

Share This Article