What Does “Washing Out CGT On Incorporation” Actually Mean?

What Does “Washing Out CGT On Incorporation” Actually Mean?

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The way we prefer to explain “Washing Out CGT On Incorporation” is by using an analogy in the first instance and then relating it back to the question.

Imagine you have just cleaned a muddy floor with a white towel. The towel isn’t white any more is it? This is because the mud has been transferred from the floor onto the towel. The floor might well be clear of mud but the towel isn’t is it? The mud still exists, it has merely been transferred.

Now imagine washing the towel in a bucket of water. You can wash the mud out of the towel but the mud remains in the water doesn’t it?

In both scenarios there is no less mud after the transition than there was before. You have simply moved the unwanted mud from an inconvenient position to a more convenient position for you.

In this analogy, the mud represents the capital gains on which CGT is ordinarily payable. The towel represents shares in your new company and the bucket of water might represent your long term exit strategy.

When a property rental business is transferred into a company it is treated as a sale, which crystallises capital gains. For example, if you acquired a property for £100,000 which is now worth £500,000 the capital gain is £400,000. However, a piece of legislation called TCGA92/S162 enables business owners to exchange equity in their business for shares and to offset the value of the shares created (the value of the equity in the business) against the capital gain resulting from the sale of the business, to reduce or even eliminate the payment of CGT at this point by deferring it. Effectively, the capital gains have been transferred from the properties into the shares in the company, much like the mud being transferred from the floor to the towel, or the towel into the bucket of water.

Imagine a scenario where a property was originally purchased for £100,000 but transferred to a company for £500,000. If that property was sold for £500,000 the following day, the company would have made no profit, hence there would be no capital gains. This is because the £400,000 of capital gain has been washed out of the property and into the company shares. Therefore, the CGT is deferred until the shares (not the properties) are disposed of.

However, there are two scenario’s at least where CGT would not fall due on disposal of the company shares. These are:-

  1. If the owner of the shares dies before they are transferred – rather an extreme way to avoid paying tax though!
  2. The second second is if the shares in the company are sold to a REIT. This is the equivalent to my analogy of washing the towel in the bucket of water.

Given that property investment strategies change, it may well be that you own properties which you would not buy again at todays prices. Likewise, you may well be able to reinvest the money you have got tied up in those properties into better performing property based assets. However, you may well be hanging onto those properties because they are heavily pregnant with capital gains. If you are in this position, then incorporation of your rental property business might be the solution you are looking for.

Key Points To Consider BEFORE You Incorporate

  1. How much better off will you be? To help you to calculate this we have developed software you can download for just £97 – details via THIS LINK
  2. Will CGT be payable? Given that you will be selling your properties to the Limited Company, you will be crystallising your capital gains. Ordinarily, this would mean that Capital Gains Tax is due. However, in certain circumstances, ‘incorporation relief’ will enable you to roll some or all of the capital gains into shares in your Limited Company which you exchange for equity in your properties. The rules are explained HERE. The software mentioned above also calculates the CGT position for you.
  3. Will the company need to pay Stamp Duty when the properties are transferred into it? Given that the company is essentially buying the properties from you, Stamp Duty would ordinarily apply. However, in certain circumstances, relief is available. The rules are explained HERE. The software mentioned above also calculates the Stamp Duty position for you.
  4. Will you need to refinance? The costs of refinancing can be extremely high. Furthermore, if you are tied into mortgage deals with early repayment charges or you have particularly competitive financing terms already, it may not be economically viable for you to apply for new mortgages in the Limited Company name. However, there are legal structures available which enable you to defer new financing until it is financially viable for you, or to the end of the existing mortgage term. Details HERE.

For just £400 we can complete a full Fact Find and analysis of your position and then prepare a bespoke report and recommendations outlining the optimal adaptation plan for you.

This can then be checked by your existing professional advisers and our Hon. Legal Counsel, Mark Smith, Head of Chambers at Cotswold barristers who will adopt our recommendations as his own professional advice subject to you agreeing to instruct him to deal with the legal work necessary for implementation. Even after all of that, if you’re anything less than 100% satisfied you can claim a full refund of our £400 consultation fee under our GUARANTEE of total satisfaction.

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