10:00 AM, 31st December 2012, About 10 years ago 12
“Milking the Buy-to-Let” is a Landlords Tax Planning Strategy which is very much under utilised. The strategy applies only to married couples and Civil Partnerships and is used to offset mortgage interest against rental income, regardless of whether the amount borrowed exceeds the original purchase price and also regardless of how the proceeds of the finance are used.
HMRC rules are that you can’t claim tax relief on any borrowings exceeding the amount you paid for a buy-to-let property (known as the base cost) unless the excess amount is used for reinvestment into the business. The tax man “HMRC” will not accept that a new car, holiday etc. is a business investment. HMRC will accept that improvements to property or utilising additional capital to purchase investment property is reinvestment.
Landlords should keep a balance sheet and need to be very wary of having a negative capital account, i.e. drawing more out of the business than they have invested into it and made in terms of rental profits. This is a very clear flag to HMRC to investigate what percentage of mortgage interest relief is being offset against rental income.
A strategy I created which was subsequently labelled “Milking the buy to let” as a solution to this problem was picked up by the ACCA and communicated to all of it’s members following a CPD course I held with their Norwich branch several years ago.
There is a way to structure financial affairs between married couples and civil partners to avoid issues associated with negative capital accounts. The short explanation is that transfers of property between spouses are CGT exempt. Therefore, if Mr sells to Mrs for a profit there is no CGT. The sale/purchase price is considered to be the new base cost against which mortgage interest offset against rental income, regardless of the purpose. The original base cost is applied for CGT calculation purposes if the property is sold to a third party before death though.
Let’s assume Mr and Mrs X each buy a property for £100k, let’s say with the benefit of an 80% interest only mortgage to keep things simple.
Some years later the properties have doubled in value so they are worth £200k each.
Mr and Mrs X decide they can want to buy themselves something a bit special, they decide on a £100k motor home which they will never rent out, it could just as easily be a Ferrari. They need to raise the finance and turn to their buy to lets.
Mortgage lender says no problem, we are very happy to give you both a £50k further advance.
Great they think.
The problem is that if they proceed to do this they will each have a mortgage of £130,000 against a property which is worth £200k but only cost them £100k. Therefore, they are borrowing £30,000 more than they paid for the property.
Based on what I explained above, this is all fine so long as they only offset the mortgage interest on £100,000 against rental profits and not the full £130,000 mortgage.
However, here’s the clever bit….
Using the strategy I explained above they could sell their properties to each other for £200,000. Yes that’s a £100,000 capital gain but CGT is not payable on transfers of property between spouses.
Mr X then borrows £130,000 towards the purchase of the property from Mrs X and Mrs X then borrows £130,000 towards the purchase of the property from Mr X.
The net result is that they still end up with a net £100,000 to go and spend on their motor home or Ferrari.
HOWEVER – as all of the funds raised have been used to purchase investment property they can offset the mortgage interest on the FULL £130,000 against their rental income.
It’s very simple when you know how and feel free to run this past your tax inspector.
QUESTION 1) “Is there a retrospective route one could go down with existing properties in joint names to mitigate CGT by removing say one partner from the deeds and then doing this strategy in say 10 years time to take advantage of it. I assume tax payable up to this point would be payable but you may gain 10 years tax free future growth or am I clutching at straws”
MY ANSWER – yes, this can be done retrospectively so long as your mortgage lender will play ball. Just write to them and ask how to go about taking your name of half of the mortgage deeds and your wifes off the other half. They will probably assume you are seperating or getting divorced as that’s the most common reason this happens. Don’t over complicate the issue, just tell them what you want to do. This will not change the base cost. The new base cost will be applicable when you sell your properties to your wife and she sells hers to you. This could even be the day after so it’s happy days. You will both need to repay the old mortgages and arrange new ones so there will be a cost involved and you will need to take a commercial view when you do this of whether the benefits outweigh the costs. Your point about 10 years, is therefore a red herring.
QUESTION 2) “If done retrospectively as in 1) would an alternative maybe using a company be beneficial in any way. For example selling to a company you are both directors of ( CGT payable at that point) then each of you buying it back from the company.”
MY ANSWER – Ditch that one as a bad idea. I can’t think of any scenario where this would be worthwhile.
QUESTION 3) “Are their any negative implications in the strategy – for example if the partners were to split and divorce before selling to each other. Presumably not if they bought one alternatively as they built the portfolio but it could get potentially messy if the houses they sell to each other were unequal value. But no more messy I guess than any divorce would be.”
MY ANSWER – there are costs of using this strategy and a commercial decision needs to be taken. Costs are stamp duty, legal fees and the costs of obtaining new mortgages. Your retrospective strategy will also involve some small costs as lenders are likely to make a charge for removing a person off the mortgage deeds if they agree to do that and you will need a solicitor too. Other than costs there are no real negatives. Divorce would probably require assets to be split anyway so in a strange sort of way, doing it whilst you are not thinking of getting divorce could actually make a divorce sitiation slight less stressful and adversarial if a relationship were to break down after instigating this planning.
QUESTION 4) “What would be the costs involved for strategy 1) and 2) if feasible”
MY ANSWER – it depends. I’ve explained above how the costs arise but each case would need to be costed individually as there are too many variables in terms of lenders fees, property values affecting stamp duty etc. for me to offer any realistic ballpark figures.
QUESTION 5) – Is this not Tax avoidance?
MY ANSWER – it is indeed Tax Avoidance which is perfectly legal. I think you might mean Tax Evasion which is illegal – this strategy is not illegal. Please see this post for a better explanation and actual Case Law which two Judges have very eloquently summarised in just one paragraph each.
QUESTION 6) “brilliant strategy – I’m sure it was legit – however (and I’m uncertain here!) – would the new gaar rules against artificial tax avoidance cover this now?”
MY ANSWER – I do not believe so. However, I really must point out that my post here must not be read as advice or taken as professional advice in any way. I am merely sharing a strategy which could possibly now be out of date, although I don’t think it is. Anybody wishing to progress matters should take their own professional advice from appropriately qualified tax/legal advisers with adequate Professional Indemnity insurance. I do not fit this description, nor do I own a stake in or earn commission from any business that does so I can hand on heart state that I’m not touting for business. I will, however, be pleased to refer anybody who’s genuinely interested in this strategy to my personal professional advisers if requested. If anybody takes me up on this and they are happy they can buy me a drink if they want to.
Associated reading – please see >>> “Is your property portfolio ownership structure optimised to enable you to pay the minimum amount of CGT, income tax and IHT?“
My name is Mark Alexander, I’ve been a landlord since 1989 and developed a substantial property portfolio. I’m also the founder of Property118.com – I’m not an accountant but I have learned a lot about tax as a result of having employed a very good firm which has a specialist tax section just to look after landlords and property developers like me. If you would like me to introduce you to the firm I use, with no obligation of course, simply complete the form below.