Structuring property ventures
At its most basic level, property can be held either directly (by you as an individual, whether wholly or in partnership with another person(s)) or indirectly through a company or a discretionary trust. This note does not consider trust ownership of property or ownership through a self-invested personal pension (SIPP), but we can advise you on these areas if either is an option you would like to explore.
It is often the case that people look to tax considerations to drive the choice of property holding structure, but you should not overlook the importance of the impact that finance-raising and general practicalities can have on structuring. Whilst this note is aimed at explaining the relevant tax issues for structuring, before making any final decision on structure you should also consider:
(i) how you want your business to operate administratively (do you want the additional accounting and administration costs that go with using a company?)
(ii) how you want to deal with succession (when you want to exit your business is it something you want to pass to your children, would you want to shut it all down or would you sell to a third party?)
(iii) will you need to get external finance to assist with the cost of purchasing property, and if so, what are the bank lending criteria like if you operate as a company as against direct ownership (this is one reason why discretionary trust structures often do not work)?
(iv) do you want to retain profit in the structure to grow it, or do you need the profit to cover your day to day lifestyle?
(v) are you using the structure for one project or for multiple projects?
These are just a few of the practical points that you will need to consider.
What we have summarised below is a basic overview of the main issues and considerations involved in deciding how to hold property that is acquired or held for purposes other than personal occupation as the main home. It is invariably the case that a main home for personal residence should be held directly in a personal capacity. There will be very few instances (if any) when holding your primary residence through a company will be tax effective.
That said there are circumstances where indirect ownership structures (such as companies) for holding property are appropriate and offer certain advantages. For example, properties which are acquired for the purposes of a property rental, development or trading business may benefit from being held in a company (primarily because of the difference in tax rates between corporation tax and personal income tax). Each of these aspects is discussed briefly below.
Ultimately the question of what structure will suit your individual purposes best will be answered by looking at your personal circumstances and aims; there is no one uniform answer to the structuring question. However, we hope that our explanation below will at least enable you to feel more informed about the options available to you.
Property investment (rental) businesses
This category covers those businesses that purchase property (whether residential or non-residential) to hold as a long-term investment and to let out to tenants (this is often what is referred to as a “buy-to-let” business). Such businesses are not considered to be trading businesses, and the property purchased is usually classed as an asset of the business to be recorded on the balance sheet.
Over the last few years the decision about how to structure such business (at least on a small scale) has become increasingly complicated. This is due to the myriad of tax legislation being used to try to influence how the UK property market operates. An economic model was starting to develop that saw many of the lower value properties being purchased as investment properties for rental, which lead to a shortage of “first step” properties being able to those trying to initially get onto the property ladder. To restrict this, the UK Government introduced tax legislation to remove some of the tax reliefs that had previously been available to those purchasing properties to operate as a business. These restrictions included a reduction of interest rate relief in calculating taxable business profits, increased stamp duty land tax rates for those purchasing additional properties and an annual tax on residential properties valued at over £500,000 held by companies. Most recently we have seen an increase in the rates of capital gains tax for the sale of residential property (excluding principle private residences) and an extension of the UK residential property tax ambit to offshore ownership in order to ensure that offshore ownership of UK residential property is subject to the same UK tax rules as ownership by UK tax residents.
As tax legislation currently stands, if an individual purchases and holds property to operate a property rental business they will find that they are subject to the following tax constraints:
(i) the rate of capital gains tax on the sale of residential property (other than a principle private residence) is an increased rate of 28% (for higher rate taxpayers) as opposed to 20% (being the higher rate of capital gains tax that applies to the sale of any other kind of asset);
(ii) an individual who already owns a residential property or a share in a residential property, whether in the UK or elsewhere, faces, in most circumstances, an additional SDLT charge of 3% on top of the scale charge that would otherwise be payable when a further residential property is purchased;
(iii) an individual owning UK residential property that is subject to borrowing will be restricted in terms of the amount of finance costs (including interest rate relief) they can claim as a deduction in calculating taxable profits from the business. It means that all finance costs (not just loan interest) are no longer an allowable expense when calculating taxable rental profits. What is now available is a basic rate tax deduction after the rental profits have been taxed. This deduction will be up to 20% of the finance cost. This impacts all taxpayers who own residential property in their individual capacities, who incur finance costs and not just higher rate taxpayers. Finance costs include mortgage interest, any payments that are equivalent to interest, and incidental costs of obtaining finance, such as fees and commissions, legal expenses for negotiating drafting loan agreements or valuation fees required to provide security for a loan.
In contrast to the direct personal ownership position, if a company purchases and holds property to operate a property rental business, the company will find that it is subject to the following tax constraints:
(i) if the property is held by a company, then both UK and non-UK tax resident companies will be subject to corporation tax on their UK rental income at a rate of 17%. Certain expenditure associated with the property may be deductible to reduce the total tax payable on rent, including maintenance and finance costs. Of particular importance is that finance costs will still usually be allowed in full as a deduction against calculating taxable profits where a company is purchasing property;
(ii) a company, whether in the UK or elsewhere will pay an additional SDLT charge of 3% on top of the scale charge that would otherwise be payable when a residential property is purchased, this will apply even if it is the first (and only) residential property that a company purchases. There is also a higher rate of SDLT at 15% (which is an absolute ceiling, there is no higher rate) where a company (or other non-natural person) purchases a residential property for consideration in excess of £500,000; although there are reliefs available including where property is purchased for the commercial exploitation through generating rents;
(iii) the annual tax on enveloped dwellings (ATED) is payable every year in which a company owns a UK residential property valued at more than £500,000 (including properties held by partnerships with a corporate partner and certain collective investment schemes). No ATED is payable if the company in question runs certain businesses with respect to the property for the whole year, including property development and commercial lettings to third parties. However, the company must still file annual ATED tax returns and obtain valuations at certain intervals. It is important to note here that it is necessary to comply with the conditions of the exemption for a period of three years following purchase, failing which, the difference between the SDLT paid and the 15% charge will be clawed back. This would be the case if the property were occupied by one of the directors or persons connected with them instead of being let to a third party.
However, there are also tangible benefits to owning residential property through a company. Most obviously is the fact that the rate of corporation tax on business profits is considerably lower than the rates of income tax where property is held personally. T his needs to be balanced alongside the fact that the net business profits will belong to the company; meaning that if you want to extract profits from the busines you will need to declare a dividend, which will attract a further level of taxation.
In addition to the difference in tax rate between corporation and income taxes is the fact that the restriction on the deductibility of interest for individual buy-to-let landlords and the imposition of special rates of capital gains tax (i.e. the increased rate of 28%) make the option of owning residential investment properties through a company more attractive.
It can feel quite overwhelming to have to weigh up this number of issues to decide how best to structure your own business. We can assist you with this process. We may not be able to simplify the rules, but we can assist you in interpreting them for your own circumstances to get you into the best possible position.
How can I go from owning a buy-to-let business personally to holding it in a company?
If the discussion above has prompted you to consider owning your existing portfolio of buy-to-let properties through a company, then we can advise you on how to make the change.
What you would need to do is to incorporate your existing personally held business. There are a few tax considerations to keep in mind. These are discussed in a separate article that we have produced which can be found here.
Property development structures
This category relates to those businesses that purchase property to either convert or develop for sale on. This type of business is usually treated as a trading business for UK tax purposes, and the property that is purchased for development is classed as trading stock and not as an asset on the balance sheet.
There is a wide array of tax issues that need to be considered when structuring a property development business, and the extent of these will vary depending upon the size and nature of the project or projects. In some cases, VAT will have a big impact. Specialist tax advice should always be sought at the outset when looking at larger scale or multiple projects, particularly those that involve developing flats within a freehold block setting. We can advise you on these areas, but it is not something that can be easily summarised in a guidance note.
In this article we consider only the basic position, and we do so only in a high-level way in order to give you an idea of the issues you will need to have regard to.
A property development business is usually subject to either income tax (if you are a sole trader or in a partnership) or corporation tax (if the business is operated through a company). The current difference in tax rate between these two regimes can be a big influence for people deciding how to structure their property development business. At present the higher rate of income tax is 40% (additional rate of 45%), whereas corporation tax is 17%.
However, you cannot forget that even though the rate of corporation tax is considerably lower, if you need to extract net profit from the business, where that business is operated through a company, you will encounter a second tax point on extracting those business profits. The expected way to remove profit from a company is to declare a dividend. The current rate of tax on a dividend payment received by an individual is 32.5% for higher rate taxpayers. What this means is that you can either pay a higher rate income tax bill of 40% to get the profits from the business direct into your hands for personal use, or you can pay corporation tax at 17% followed by dividend tax at 32.5% (a total tax cost of 49.5%) to get into the same position.
It is for this reason that the first tax planning consideration when deciding how to structure a property development business is often: do I need to extract the net profit immediately on completion of a project to cover my living expenses, or can I leave the profit in the company and grow the business? Absent other practical considerations, we find that if a client needs to extract profit regularly to cover basic living costs, then they should be cautioned against using a company structure.
Having considered this fundamental point, the tax issues that then follow for consideration tend to be specific to individual circumstances, it is therefore necessarily too involved and detailed to summarise them here. For example, some property development projects will involve acquiring land for new build projects, whilst otherwise will be buildings acquired to convert into flats. The tax and structuring considerations for each of these types of project are very different. We also commonly encounter home owners with large gardens that they want to build one or two house on. The tax issues here are of a very different nature to those encountered by someone acquiring land to develop.
In any of these cases our specialists will be able to advise you on the best approach to making legitimate tax savings through careful structuring.
Just a one-off development project?
This is a note of caution.
You might think that because you have undertaken only one (or possibly two) property development projects that you couldn’t possibly be deemed to be trading; particularly if you have occupied the property you were developing. However, the tax rules are not as simple as that. If you acquired the property with the intention of developing it for sale (even if you lived in it for a brief period whilst developing it) the mere fact that you acquired it intending to develop it and sell straight on could mean that you are deemed to be trading for UK tax purposes. Therefore any “gain” that you made on selling the developed property could fall to be taxed under income tax rules.
It is beyond the scope of this article to discuss these issues in any detail, but we can advise you further if you are concerned that this set of rules might apply to you.
This note provides only a basic summary of the most common property holding structures. There are many other alternatives such as holding property through a self-invested personal pension (SIPP), using offshore structures (trusts and companies, although the difference between UK companies and non-UK companies holding property is diminishing from a UK tax perspective) or real estate investment trusts (REITS). All of these options are very much individual circumstance specific. Our specialist advisers would be happy to discuss with you all the options that may be relevant to you.