Tax Traps of Incorporation of Buy to Let Property Portfolio

Many landlords will know or have been taught this. Normally landlords are advised to refinance their properties as and when possible to extract as much cash out as possible and spend it on their personal leisure.

However this can create the major problem when incorporating your portfolio, because if the debt on the asset is greater then the base cost, i.e. your purchase cost plus any refurbishments, then on incorporation there is a special charge alled to the latent gain. So HMRC will grant you Incorporation relief under S162, but will restrict this by the amount that your debt exceeds the base cost, which means you can technically be liable for any Capital Gains Tax on this amount.

I will demonstrate this with an example:

You buy a property in 2015 for £150,000
And at the time you have a mortgage of £100,000
& Equity of £ 50,000

Then in 2017, the property is refinanced, and the value is then £250,000
& you refinance it for with new mortgage of £185,000

Then in 2022, you decide to incorporate, and your current value is £400,000
HMRC will give you incorporation relief of £215,000
& you will be liable to CGT on £ 35,000

This is just a basic example for demonstration purposes. But imagine if you have 10 or more properties, and you have done the same for each and every property, the cost of incorporation may not justify the benefit.

One way of overcoming this is to payback to the business the amount of excess, however not everyone will have access to such funds, unless they have sufficient equity in their own home to refinance & repay the excess debt. Or you can use the excess debt to purchase additional properties and expand your portfolio.

The other tax trap is Stamp Duty Land Tax, an exemption is only available to partnerships that have been established for 3 or more years. If you don’t have a registered partnership you do run the risk of an enquiry. To get round this, many landlords have been poorly advised to form a partnership with another person who becomes a minority partner, i.e. less than 10% profit sharer. The main issue here is that even the minority partner has to have an active role is management of the property business, and has to have a ‘real’ share of the profits, not just a paper share, which means you have to give them their share of the profits, from which they will pay their own share of the tax liabilities. Many have also been adviced to form an artificial partnership, where there are in partnership with a company of which they own more than 50% of share capital and voting rights. This has been tested in a case in February 2020, and it was deemed as tax avoidance. A partnership has to be legitimate with another person or a company in which you have no control over. Over the years, SDLT has become very expensive tax, and with additional 2% surcharge for non-residents landlords can cost you up to 17% of the transfer price on incorporation, so if the market values are deliberately undervalued or below market value transfer, the Valuation Officer at HMRC will challenge this!

At JMS Accounting Services, we always carry out an in depth feasibility study. Incorporation need not be expensive if done correctly, but if done incorrectly can cost you a lot more than you bargained for!

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