Latent Gains Impact On Finance Cost Tax Credits + CGT At Incorporation Of Property Rental Businesses

Latent Gains occur when the total liabilities of a property rental business exceed the total acquisition costs of the business, also known as ‘Base Costs’ for CGT calculation purposes.

This is why it is so important for Accountants of property rental business owners to maintain an accurate balance sheet in addition to profit and loss accounting and filing tax returns.

If you engage an Accountant who does not keep a balance sheet for you, then you should seriously consider changing your Accountant for one who understands taxation of property rental businesses. This is because they could be filing your tax returns and CGT returns incorrectly. HMRC has the right to charge penalties for incorrect reporting and interest on underpaid tax, so this really is very important.

Finance Cost Tax Credit Example 

Let’s suppose the Base Cost of your property rental business was say £3,000,000 but your liabilities (mortgages) were say £4,000,000.

Based on the above you would have a Latent Gain of £1,000,000.

In this scenario, the 20% tax credit you’re allowed to claim against finance costs can only be applied proportionately, i.e, 75% in this scenario.

If you were to claim the 20% tax credit against all the finance costs then you would have underpaid tax.

Incorporation Relief Example

Using the same numbers as above, Incorporation relief would also be applied proportionately. Solutions to this would be:-

1. Pay CGT on the £1,000,000 of Latent Gain within 60 days of incorporation
2. Pay down mortgages or other liabilities by £1,000,000 prior to incorporation
3. Introduce £1,000,000 of additional share capital by adding £1,000,000 of cash at the point of incorporation
4. Consider becoming non-resident, especially if you owned a significant proportion of your properties prior to April 2015. This is because Base Costs are automatically uplifted to the April 2015 value of properties for non-residents.
5. Separate the business into two separate businesses by transferring the properties with the largest Latent Gains into an LLP. There are no Tax and SDLT implications on doing this if the capital accounts reflect the current ownership. This is because LLP’s are tax transparent. Furthermore, because an LLP is a separately registered legal entity it is then a different business. If the remainder of the rental property business still meets HMRC;s “meaning of business” test on eligibility for full ‘incorporation relief‘ that business can then be incorporated without the Latent Gains problem.
6. There is one other option but we rarely recommend it because it only defers the problem and carries risk. Nevertheless, where incorporating is the financial salvation for a business that is otherwise failing we will consider recommending it.

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