As announced in August 2016 and confirmed at Spring Budget 2017, the government will legislate in Finance Bill 2017 to allow most unincorporated property businesses (other than Limited Liability partnerships, trusts, partnerships with corporate partners or those with receipts of more than £150,000) to calculate their taxable profits using a cash basis of accounting. Landlords will continue to be able to opt to use Generally Accepted Accounting Principles (GAAP) to prepare their profits for tax purposes.
Note the wording carefully, Landlords will be automatically in Cash Accounting and have to Opt Out, normally, its the opposite way round you have to Opt into Cash Accounting if you are a Trading Business.
Under the cash basis, capital allowances, except on the provision of cars, are not available. Instead, landlords will be able to claim the upfront cost of capital items used in the business.
As for those who do opt to use GAAP, the initial cost of items used in a dwelling house is not an allowable expense under the cash basis. The existing ‘replacement of domestic items relief’ will continue to be available for the replacement of these items when the expenditure is paid.
Interest expense will be treated consistently between those using the cash basis and those using GAAP.
In theory it is simpler just reporting Cash In and Cash Out, but it doesn’t always work in your favour, for example:
Finance – if you buy equipment or furnishings on finance cash accounting restricts you the repayments rather than the full value under UK GAAP
Profits can be higher as there are no accruals or provisions
Will Cash Accounting work for your property business?
Pensions are highly tax efficient and you can purchase Commercial Property, the main examples of types of property your pension could buy are
Industrial units
Offices and shops
Farmland and forestry
Public houses
Nursing homes
Hotels
Marine berth
The things you can’t buy are residential property, holiday property, caravans, beach huts, basically, if you can live in it then it will probably be difficult to put it your pension.
If your business owns its premises or you have mixed property investments where you can title split to separate the commercial from the residential it could well be worthwhile to move the commercial property into a pension scheme (SIPP or SSAS).
The tax benefits are:
When you or your business contribute to your pension scheme the contributions are tax free – for individuals they will will get back tax at 20% and can claim additional tax relief on their self assessment return, for companies they can save 20% corporation tax
When the property is in the pension scheme there isn’t any tax on the rental income or capital gains tax if you sell the property
When you retire you could get 25% of your pension tax free
Other benefits include:
Your business could use cash tied up in the premises to invest in trading activities or for other investments
Pensions are normally outside of the scope of inheritance tax
It will ring fence your property from your other activities
In summary to move your business premises from your business to a SIPP or SSAS pension you would do the following:
Find a lender prepared to lend a third of the property value to your pension scheme (which will be half the value of the fund ie if the property was valued at £300k, your pension could borrow £100k which is 50% of the £200k which will need to be funded by your pension scheme)
Have the premises independently valued and rent assessed and appoint solicitors
Create a SSAS or SIPP pension (you can include other people in your SSAS or SIPP investments)
Transfer into your SSAS or SIPP any funds you have in other pension schemes
As you are the business owner and its your pension scheme your business could make a payment into your pension scheme (pension contributions are tax deductible), the maximum for the last 3 years would be £120k (£40k + £40k + £40k) see details of NRE
You could make a personal payment to your pension and if you are a higher rate tax payer your will get a tax refund via your self assessment return
Then your pension scheme buys the premises from your business and rents it back to the business
Firstly, we all know there are many advantages to using a company for property investment.
The main driver has been the S24 Restriction of Mortgage Interest Tax Relief
2017/18 75% of the interest can be claimed in full and 25% will get relief at 20%
2018/19 50% of the interest can be claimed in full and 50% will get relief at 20%
2019/20 25% of the interest can be claimed in full and 75% will get relief at 20%
2020/21 100% will get only 20% relief
For a 20% tax payer that’s fine but for higher rate taxpayers its a disaster that will lead to them paying a lot more tax
These rules will not apply to Companies, Companies will continue to claim full relief.
Companies have many other advantages too:
Stamp Duty on Shares is 0.5% so if you own each property in a separate company you can sell the shares rather than selling the property
Holding properties in separate companies makes it easier for lender to take a charge over the business assets
Companies are better for Inheritance Tax Planning enabling the company shares to be given away in stages
Corporation tax is 19% and falling which means if you want to grow you portfolio you will retain more of the profit for re-investment
Those investors moving an existing portfolio will probably have to move all the properties to a single company in order to benefit from S162 Incorporation Tax Relief.
Let’s look at some of key points in more detail
Mortgages
At the moment company mortgages are probably 1% more expensive than individual Buy to Let Mortgages but that is is bound to change as more people switch to companies.
Lenders will probably want:
A Charge over the Property – these are legal charges registered at Companies House
A Debenture – these are charges over all the companies assets for example cash and rent arrears – this is fine if its one property per company but impossible if you have multiple properties and multiple lenders in a single company
A Personal (Directors) Guarantee – where you have a group structure a Parent (Holding) Company guarantee will probably be a good option if you have to give a directors guarantee you can insure against the risk of it being called in for example http://www.pgicover.co.uk/
The mortgage is with the company, so if you want to sell an investment I think buyers will be interested in buying the company as it avoids re-financing costs.
Bank Charges
Banks will charge for each account and companies need their own bank account, but generally the cost is low, for example
The Holding Company can provide management services to the subsidiaries and also recharge shared costs.
It can lend money and get dividends from the subsidiaries (this would be Franked Investment Income so its not double taxed).
The Holding Company could employ staff.
Accountancy
We offer deals to make this structure costs effective, I am sure other accountants will too. The subsidiaries should be cheaper to operate than the holding company.
Tax Simplicity
In addition to Residential Investments and HMOs you might have Rent to Rent, Commercial, Development and Serviced Accommodation, keeping these in separate companies makes it easier to deal with Tax and Risks, for example some might be VAT registered where as others might be Exempt.
Stamp Duty
SDLT on Shares is 0.5% but its much higher for buyers who buy properties.
Property Investment is probably one of the most complicated tax and accounting activities that exists, it can involve:
Stamp Duty (SDLT)
Income Tax
Corporation Tax
ATED
Capital Gains
And some activities also involve Pensions, Capital Allowances, VAT, CIS…. the list goes on and on
The internet is full of experts but often their advice is conflicting and some of the advice is actually wrong!
Experience gained from working with investors is the key to knowledge and continuous training and updating is vital. We have written hundreds of blogs on tax and accounting.
Landlords will no longer be able to deduct all of their finance costs from their property income to arrive at their property profits. They will instead receive a basic rate reduction from their income tax liability for their finance costs.
Landlords will be able to obtain relief as follows:
in 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction
The rules don’t apply to companies
I also think that having actual property and construction experience is beneficial.
Back in 2003, we started investing in property with a group of friends and colleagues.
We started by forming a limited company and our first purchase was 3 shops (eastern Eye, Maximum and LMJ) with 8 HMO’s above, there is a picture below
We then went on to buy 6 shops with flats above on long leaseholds, we did a title split and put 3 of the shops into SIPP Pensions
We then formed another company and purchased a block or 7 HMO’s.
We also bought an Office Block, Industrial Unit and Shops into SIPP and SSAS pensions.
We sold our investment in the companies and focused on commercial property investments in pensions.
During October to December 2016, 69% of all new Buy to Let purchase applications were made by Limited Companies according to Mortgages for Business.
The percentage of remortgage applications in company names also increase to 31% in Q4 up from 23% in Q3 last year.
The total number of lenders offering Buy to Let finance to limited companies remained stable at 14 and the total number of products available rose slightly from 195 in Q3 to 198 in Q4.
This is despite the fact that lenders are still charging higher rates of interest for companies, often 1% extra.
I think lenders will very soon be forced to bring rates into line as competition amongst lenders increases.
The main driver has been the Restriction of Mortgage Interest Tax Relief
2017/18 75% of the interest can be claimed in full and 25% will get relief at 20%
2018/19 50% of the interest can be claimed in full and 50% will get relief at 20%
2019/20 25% of the interest can be claimed in full and 75% will get relief at 20%
2020/21 100% will get only 20% relief
For a 20% tax payer that’s fine but for higher rate taxpayers its a disaster that will lead to them paying a lot more tax
These rules will not apply to Companies, Companies will continue to claim full relief.
Companies have many other advantages too:
Stamp Duty on Shares is 0.5% so if you own each property in a separate company you can sell the shares rather than selling the company
Holding properties in separate companies makes it easier for lender to take a charge over the business assets
Companies are better for Inheritance Tax Planning enabling the company shares to be given away in stages
Corporation tax is 20% and falling which means if you want to grow you portfolio you will retain more of the profit for re-investment
Companies have to be the way forward for investors.
Property converted or adapted as residential property
The definition of residential property is a building or structure that is used or suitable for use as a dwelling. It does not therefore apply to property, including land, which is not residential property when the investment-regulated pension scheme acquires it. But the building or structure may become residential property whilst owned by the pension scheme as a result of being subsequently subject to development.
Whilst it is in the course of construction, conversion or adaptation such land and property is not residential property because during that period it is not suitable for use as a dwelling.
Land and buildings being converted are treated as residential property from the point when they become suitable for use as a dwelling.
In any specific case this point should be determined by taking a common sense approach to the facts and circumstances.
Essentially the question to be answered is: would a person normally live in that dwelling?
The point at which this occurs will normally be when the works are substantially completed. In the case of UK property this is likely to be when the certificate of habitation is issued.
A property that is sold before the development or conversion is substantially completed never becomes residential property.
With all the recent changes in Property Investment Tax rules some investors have sought to move their property investments into LLP’s
Limited Liability Partnerships have largely been ignored by HMRC and untested with case law (so there is a risk that HMRC will start to pay more attention to them if they grow in popularity).
LLPs could have some benefits, especially for Inheritance, let’s look at the advantages:
If you had a property portfolio with potentially large capital gain you could move the property to the LLP as equity capital introduced (be careful on how the LLP agreement is written) and in theory this wouldn’t create a capital gain (CGT)
The LLP will show the full value in their accounts including the gain
Then you can add other family members
LLP’s are also being used as a stepping stone to incorporation.
S162 Incorporation Tax Relief would probably be available once the LLP has been trading for a while
Where the transferor is a partnership, this normal rule is overridden by the prescriptive rules in FA 2003 Sch 15. The impact of these provisions can be that to the extent the company is connected with the partners making the transfer, no SDLT may arise. https://www.taxjournal.com/articles/incorporation-buy-let-business-10062015
There are specialists offering solutions such as Property 118 – but the fees may out way the benefits for many investors
I would recommend a company for each property as this should make it easier for lenders to take a charge and creates the opportunity to sell the company rather than the property within it.
Buying properties into you own property development company is very popular and there are lots of TV programs that tell you how much you could make.
Property Development is a trade where as property investment isn’t.
So what happens if you develop a property and then decide to keep it as an investment rather than sell it?
This known as reclassification and there would be an immediate deemed disposal under TCGA 1992, s 161 as a result a taxable trading profit would calculated based on the market value. The tax would be payable even though the property had not been sold and a profit had not been realised.
The courts have looked for the following evidence of reclassification:
Balance Sheet reclassification moving the asset from Trading Stock to Fixed Assets
Transfer of the property to an investment vehicle including Group Companies
Board resolution that property is being held as an investment
If the market value is below carrying value at the time of appropriation, this would create a trading loss which can be offset against other profits in the year or group profits.
‘Slice of the action’ contracts are so called because they confer upon a landowner (who holds the land as an investment) the right to share in the proceeds of any subsequent development by the purchaser. In these cases, the contract for sale of the land to a builder or developer provides for consideration that is, in whole or in part, contingent upon the successful development of the land.
A common arrangement is for the landowner to receive a fixed sum at the time of the disposal, plus a percentage of the sale proceeds of each building subsequently constructed by the purchaser on the land. [BIM60350]
‘Slice of the action’ clauses are also known as ‘Overage’ and ‘Uplift’ they are subject to anti avoidance rules because an advantage could be gained by the land owner being tax on the ‘slice of the action’ as a capital gain instead of being tax on it as trading income. There could be a difference of 25% tax between the treatments!
Often the vendor and their legal advisers are unaware of the anti-avoidance provisions for transactions in Land.
The provisions are drawn in very wide terms. Therefore, it is not possible to provide a summary of all the situations in which the rules are applicable, although there is a list of cases in which the rules should be considered in BIM60337.
There are, however, two common situations in which the rules are regularly invoked:
Its important that starting with the Heads of Terms the legal documents clearly show the intentions of the parties.
There is a formal clearance procedure available for taxpayers who think that these rules may apply to a proposed transaction or a transaction that has already taken place (see BIM60395).
HMRC must give the applicant a decision on the transactions in land clearance within 30 days. Therefore, any clearance applications received should be identified as such and sent to the Clearance and Counteraction Team for consideration as soon as possible.
Once HMRC give a clearance, the transactions in land provisions cannot be invoked in respect of that disposal in relation to that taxpayer.
In a ‘slice of the action’ contract (see BIM60350) the following legislation is normally relevant:
S756(3)(d) ITA 2007 for individuals, trustees and personal representatives
S819(2)(d) CTA 2010 (for companies)
Where either of these subsections is in point, part of the overall gain may be exempted from the transactions in land rules. The effect of the exemption is to take out of the calculation of the income to be charged so much of the gain as is attributable to the period before the intention to develop the land was formed. In other words allowing the gain to be taxed as a capital gain.
They will need to keep track of the rental income and claim allowable expenses
Mortgage or Loan Interest (but not capital)
Repairs and maintenance (but not improvements)
Decorating
Gardening
Cleaning
Travel costs to and from your properties for lettings or meetings
Advertising costs
Agents fees
Buildings and contents insurance
Ground Rent
Accountants Fees
Rent insurance (if you claim the income will need to be declared)
Legal fees relating to eviction
Rent less expenses will either produce a profit or a loss.
Making a loss
If you have residential buy to let properties that you own personally you can deduct any losses from your property letting profit and enter the figure on your Self Assessment form.
You can offset your loss against:
future profits by carrying it forward to a later year
profits from other properties (if you have them)
You can only offset losses against future profits in the same business.
Incorporation
If you incorporate your Buy to Let business, see our blog in incorporation tax relief..
