How does s162 incorporation relief work for landlords?Make Text Bigger
Why might a landlord want to incorporate?
- When building a rental property portfolio, profit is often retained for reinvestment into buying more property or paying down debt. However, these profits are taxed heavily for individuals. Companies only pay 20% tax, which is scheduled to reduce to just 18% by 2020. There is even talk of corporation tax being reduced to 15%.
- Companies are not affected by restrictions on finance cost relief.
- Most non-resident landlords pay tax on dividends from UK companies in their country of residence which can result in significantly lower income tax, sometimes none at all. This is highly dependent on the country of residence.
- Greater flexibility in terms of IHT planning.
- Liabilities are limited to the value of the company. Mortgage lenders often require personal guarantees but there are many other liabilities that are ring fenced as a result of incorporation.
- Ability to raise funding by adding new shareholders.
- Ability to make pension contributions.
- There are many more!
Tax Consequences of Incorporation
When a property portfolio is transferred to a company the CGT position is no different to selling the properties to a third party, i.e. base cost (purchase price and capitalised improvements) are deducted from the open market value of the property(ies) to establish a capital gain. This gain is then added to all other income and taxed at a rate of 18% for basic rate tax payers or 28% for higher rate tax payers. However, by claiming s162 relief CGT may be substantially reduced or removed completely.
How does s162 incorporation relief work for landlords?
Section 162 incorporation is available to help negate the requirement to pay CGT when converting a business to company status.
At the point of incorporation, equity in properties is converted into shares in the company. The value of those shares can be offset against the capital gain using s162 incorporation relief. Therefore, if equity in the property portfolio is greater than the capital gain there would be no CGT payable at all.
Further opportunities for tax planning at the point of incorporation
Where equity in a portfolio is greater than the capital gain a further tax planning opportunity exists. This is achieved by increasing the amount of finance to the base cost of the property portfolio (original purchase price plus capitalised improvements) prior to incorporation.
Here’s an example:-
Base costs of property portfolio = £3,000,000
Current value = £5,000,000
Current mortgages = £2,000,000
In this scenario the landlord could increase mortgage debt to £3,000,000 and put £1,000,000 in the bank.
The landlord then incorporates and offsets the £2 million of shares against the £2 million of capital gains.
The landlord then loans the £1,000,000 in the bank to the company.
The company then reduces mortgage debt back to £2 million.
The net result is that the company now owes the landlord £1,000,000. Repayment of a loan from company to landlord incurs no income tax. Therefore, the landlord can now withdraw the next £1,000,000 of profits from the company in the form of a loan repayment without incurring any additional income tax liability.
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