Taxation may be one of the few certainties in life – according to Benjamin Franklin – but that does not make the whole subject of tax a very complicated matter.
Issues surrounding Capital Gains Tax (CGT) and its implications for landlords is a case in point, especially those considering the advantages and disadvantages of incorporating their buy to let businesses.
As the Residential Landlords’ Association (RLA) has observed, the phased removal of mortgage interest tax relief for landlords has prompted many to consider whether turning their buy to let business into a limited company – incorporation – may be financially advantageous.
Companies are not affected by the changes to mortgage interest tax relief that had been available to individual landlords, and incorporation might therefore be seen as a way of reducing the overall tax burden.
Incorporating your property business, however, might mean switching the challenges of the changed mortgage tax relief to potentially bigger challenges posed by CGT – on the transfer of the business assets to the company and the company’s subsequent liability for CGT.
To get some idea of just how complicated the whole issue of CGT might become for the individual landlord, you might do no better than consider the explanations advanced by Tax Adviser in an article dated the 27th of July 2016.
The almost impenetrable mysteries of tax law as it applies to CGT night be simplified as follows:
- incorporation involves the transfer of your whole business, including its properties, to a company – the company is effectively buying the properties from you, the individual landlord;
- the sale of those assets, through incorporation, is subject to CGT – for landlords who are paying income tax at the higher rate, CGT is charged at 28%, or 18% if they pay tax at the lower rate (these rates are considerably higher than the new 20% and 10% rates that apply to other property sales);
- if your let properties are mortgaged, there is a further complication because your lender may not allow the transfer of those assets to the company you want to set up – instead, you need to borrow (from the new company) to buy the properties before you are able to sell them on at incorporation, when you incur CGT on the full market value of your properties;
- as the landlord selling the let properties, you may qualify for “CGT incorporation rollover relief” – which helps to defer your liability to pay the tax on your capital gains;
- rollover relief is only available, however, if you are operating a buy to let “business” – which the Inland Revenue generally defines in terms of you working at least 20 hours a week in the active running of the business;
- to qualify for rollover relief, you also need to transfer the properties in return for shares in the newly incorporated company and not in the form of cash – any part of the transaction conducted in cash attracts CGT;
- in addition to the financial implications and challenges of your CGT liabilities, incorporation also involves expenditure on legal and – in all probability – accountancy fees.
As we noted in an article in our knowledge base, CGT brings no joy for landlords. Indeed, the inflexibilities built into this tax regime make it more difficult for private sector landlords to adapt to changing housing needs – with the almost inevitable result that rents are likely to go up.