CHOPPY SEAS FOR LANDLORDS –is incorporating now more attractive?

Since 6 April 2020, landlords renting properties (excluding furnished holiday lets), that they own personally rather than via a company, have felt the full impact of the restriction of the tax relief previously permitted on their mortgage interest. This radical change has been phased in since April 2017 and by the 2020/21 tax year mortgage interest suffered, rather than being treated as a wholly deductible expense in the property accounts, was instead included as a 20% deduction from the tax liability. This means that the tax relief for the higher rate taxpayer is restricted to the 20% basic rate of tax rather than being at 40% as in the past.

The higher rate taxpayer then has already started to feel the impact of this change but worse was to come. The recent spike in mortgage interest rates has increased the borrowing costs in the buy to let market which means that for the higher rate tax-payer the rate of tax relief has been halved while at the same time the interest on a mortgage is soaring. And don’t forget that there is already a 3% Stamp Duty surcharge on the purchase of non-commercial buy-to-let and investment properties. The outcome of all these combined is a perfect storm for the current landlord and a much less appealing environment for potential new investors to enter.

There are a couple of potential solutions to mitigate against this to some extent. Remember that the restriction of tax relief to 20% does not impact a basic rate taxpayer, so married couples and civil partners who jointly own properties might consider a declaration of trust to change the beneficial ownership allocation of the property if one is a higher rate taxpayer while the other is not.

Another possible solution is to consider establishing a company to own the properties. The rate of corporation tax is currently less than the rate of income tax and furthermore there is no restriction on tax relief for mortgage interest. We always say that the longer-term objectives must be clearly defined in order to make the best decision. But if the landlord already has a property portfolio, then the stamp duty and the capital gains tax burden of selling your own properties to your own new company is likely to be too great an obstacle - though there are statutory incorporation reliefs that can work in very specific circumstances.

An investor starting now with a long-term objective and who personally does not need access in the short term to the profits from his property, should look much harder at setting up a company to hold the target properties. Arrangements for a new company to raise finance may be complex but there are specialist lenders who may entertain lending, depending on the personal circumstances of the directors. Once established, the limited company’s portfolio could grow at the same time as enjoying the lower rate of corporation tax.

Any future sales of properties would be taxed at future corporation tax rates rather than the higher capital gains tax rates an individual would be liable to; though the company does not have an annual exemption allowance which for an individual is currently £12,300 pa. Remember as well that the proceeds of a future disposal remain in the company and to extract them would involve a further tier of tax, though careful planning may be able to help with this. Another route that could be of interest would be to establish a family investment company which would have bespoke rules and would enjoy potential inheritance tax and income tax savings for those involved. This is a specialist area though and great care should be taken.

Peter Bevan Bevan & Co, Chartered Accountants peter@bevan.co.uk