Property investments: what’s the best ownership structure?
One of the questions constantly posed by new property investors is – what structure should I use? Should I own properties personally (or, where joint investors are involved, in partnership)? Through an LLP? Or should I invest through a company?
It would be nice if there were a simple answer. Sadly, there isn’t. This is a case where one size definitely doesn’t fit all. Let’s look at the pros and cons below.
- This may make raising finance easier and cheaper – generally banks are happier lending to individuals than to companies, and often at lower rates
- If you want in future to dispose of the property and have access to the cash personally, it is likely to be both simpler and cheaper to do so – if the property is sold at a gain there is just one “tier” of capital gains tax (CGT), at rates between 18% and 28%, and no tax at all on the first £11,000 of so of gains (assuming that you have no other gains in the year). And if your eventual plan is eventually to leave the UK permanently, gains on commercial property made after you leave are not normally subject to UK CGT at all – but don’t overlook the possibility that gains may be taxable in your new host country. And, from 6 April 2015, gains on residential property remain taxable in the UK even if you are not resident here.
- The main disadvantage of personal ownership is that all rental profit is chargeable to tax at your marginal rate of tax. And that includes any profit that is ploughed back into repaying capital on buy-to-let loans: while interest is tax-deductible, capital repayments aren’t
- Where properties are owned jointly (whether in partnership, LLP, or simple joint ownership) each joint owner is taxed on his or her share of any income or capital gain. Where property is held in the joint names of a husband and wife (or civil partners) the default rule is that for income tax (but not CGT) purposes the property is assumed to be owned in equal shares and income is taxed accordingly unless the true beneficial ownership is different and an election is made to be taxed according to that true ownership. This can give some useful planning opportunities.
- Splitting ownership with a spouse or civil partner, and thus potentially doubling up on personal; allowances, tax bands and CGT exemptions can be tax-efficient. But if you are planning to do this, it’s sensible to do it from the start. Although you can transfer an interest in a property to your spouse or civil partner without worrying about CGT or inheritance tax (IHT), there is no equivalent exemption from stamp duty land tax (SDLT). So if consideration passes or is deemed to pass (as it normally will if property is transferred subject to a mortgage debt) SDLT will need to be considered.
- The main attraction of holding property in a company is that income is taxable at corporation tax rates (currently 20% but reducing to 19% from 1 April 2017 and to 18% from 1 April 2020) rather than income tax rates of up to 45%. This can be particularly attractive where cash has to be used to repay borrowings: debt can be repaid much faster if 80% or so of profit is available to do so rather than 55%. Remember however that the lower rate of corporation tax is effectively a tax deferral (albeit potentially a very long-term one) rather than an outright saving: if you want to get your hands on the cash personally there will normally be further tax to pay when you extract value from the company, whether by way of salary, dividend, or capital gain on liquidation.
- During the lifetime of the company the most tax-efficient way of extracting value will be by way of dividend. But from April 2016 the additional tax imposed on dividends by the Summer 2015 Budget means that the aggregate tax payable on profits received by a shareholder via a company will be higher than if the profits had been received directly. For example, the effective rate of tax for a 40% payer becomes 46% and even after 2020, when the full benefit of the corporation tax reduction comes in, will still be nearly 45%.
- The Summer 2015 Budget changes restricting the tax relief which property investors can claim for interest apply only to individuals, not companies. So from April 2017, when the restriction starts to be phased in, it may become increasingly attractive to hold debt-funded portfolios through a company. But there is a price to pay on extracting future gains.
- The CGT position for companies is different from that of individuals in three ways. First, tax is payable on gains at a flat 20% (reducing to 19% from 1 April 2017 and to 18% from 1 April 2020); second, the base cost is uplifted for inflation (which, although hardly relevant at current rates, has in the past made a significant difference and may do so again); and companies do not get any annual exemption. So for small gains the tax charge in a company will be not much less than for an individual and may be more: for larger gains a company is likely to have a lower tax cost.
- But, as with taxes on income, it is misleading to consider tax on capital gains only by reference to the taxes payable by the company itself. As with income, if you want to access the proceeds personally, there will be a further level of personal tax to pay which, when taken together with the tax at the company level, makes extracting capital gains from a company a comparatively expensive exercise. For example a property gain of £100,000 would bear tax of £28,000 if made personally leaving £72,000 net; the same gain made in a company would bear corporation tax of around £20,000 and further tax on distribution of around £26,000, leaving just £54,000 net.
- One area in which companies can give great flexibility is in sharing ownership. Personal co-ownership of properties may be legally complex, especially where co-owners fall out as to the management of the property. Giving minority stakes, or perhaps preference shares, in a property-owning company can be a satisfactory way of effectively shares the benefits of ownership while keeping effective control with the shareholder holding the controlling interest in the company.
- Finally, direct and indirect ownership of property are treated very differently on death. Where properties are owned directly, IHT will be due by reference to the values at the date of death (net of debt) of the properties but – importantly – the properties will be “re-based” to market value for CGT purposes; so realisation by the executors will not normally incur any CGT charge. By contrast, where shares in a property-owning company are held, IHT will again be due by reference to the value of the shares at the date of death, and the shares will be “re-based” to market value for IHT purposes. But there will be no “re-basing” of the properties themselves. This may be less of a concern if the property company simply passes to beneficiaries and continues to be run without substantial changes: but it may add significantly to the tax costs if on death the portfolio is sold and the proceeds distributed between beneficiaries.
So: the decision whether to hold property directly or via a company is not necessarily a straightforward one. “You pays your money and you takes your choice”. For assistance in weighing up the pros and cons, please get in touch with your usual BKL contact or use our enquiry form.
But what if you are in one structure and you now think that you’d be better off with a different one? The tax issues that arise on incorporation and dis-incorporation of property businesses are not always obvious or straightforward: check them out at our topic briefing here.