My wife and I only found Property118 a few months ago and we’ve since become huge fans. We have read dozens of your articles, mainly about the economic prospects for the rental property market, mortgages, strategies and tax.
Approximately half of our properties are on good fixed rates and the rest are on tracker mortgages without penalties for early repayment. It’s the latter we are thinking about selling.
We don’t take any money out of our rental property business. Instead we live off the profits from another business. We look at out rentals as our pension fund. However, with taxation, rising interest rates and other increasing costs we are worried that we might soon find ourselves in a position where we are forced to subsidize the rental business from our other incomes. The biggest problems for us will arise if interest rates are the same or higher than they are now when our fixed rates end. This would be untenable, so we have concluded that selling a few properties, to reduce our exposure to rising mortgage interest rates might be the way for us to go. At face value the properties without any early repayment charges on the mortgages look like the best to sell first, because they also have the lowest LTV’s and the highest equity in them.
I’ve calculated the average LTV across all 22 properties at 44.6% LTV. When we first purchased them we put 30% deposits down from the sale of another business. The reduction in LTV’s has come about partially as a result of us having taken repayment mortgages over 30 years and partially due to capital appreciation. Therefore, if we do sell some properties we will have Capital Gains Tax to pay, and that’s part of our dilemma. The properties without repayment penalties attached to mortgages are also the ones with the highest equity and are the same properties that are the most exposed to Capital Gains Tax.
My wife and I are intrigued by how incorporation can wash out Capital Gains. If we have understood it correctly, incorporation would involve us selling the whole property business to a Limited Company at market value in exchange for shares. Any Capital Gains would then be rolled into the company shares. On this basis it seems that if we then sell any of our properties after incorporation there would be no tax to pay unless the properties have gone up even further in value. Have we understood that correctly? If we have it would appear to be the logical path for us to follow.
Your understanding of how incorporation washes out capital gains is correct.
Whilst you haven’t provided all the necessary figures, it also seems highly likely that there will be other positive benefits of incorporation for you, some of which are not tax related at all. Limited Liability status is one such example.
Also, based on what you have said, it appears highly likely that you and your wife will be higher or additional rate tax-payers. If this is the case you will be paying income tax at 40% or 45% on any rental profits you do retain in your property business, minus your 20% tax credit. This is because your existing structure will not allow for mortgage interest to be offset against rental income. In a Limited Company structure you will be able to offset finance costs against rental income and the rate of corporation tax is likely to be significantly lower than your personal marginal rates of tax, so you could be looking at considerable savings there too. A ‘smart company’ structure could also enable you to solve a potentially huge inheritance tax problem you may not have thought about.
Before you rush off to form a company and appoint solicitors though there are a few other important things you need to take professional advice on. The first is whether your company will need to pay Stamp Duty when it purchases your rental property business. We suspect there may be a way to negate that completely. The second consideration is how the company will acquire the properties without repaying all existing mortgages and applying for new lending in the company name. Again there are ways around this and a Property118 Tax Strategist will be delighted to consider all of the pros and cons associated with incorporation and present their recommendations for you to consider. If you subsequently decide to instruct our Joint Venture partners at Cotswold Barristers to implement our recommendations they will adopt them as their professional advice, for which they carry Professional Indemnity insurance of £10,000,000.