By transferring your property portfolio into a limited company, you can defer and save on tax. Incorporation Relief can help landlords save on Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT). Dean Castledine, Private Client Director at PKF Smith Cooper, explains how the relief works and the benefits for landlords.
What is Incorporation Relief?
Incorporation Relief is a tax benefit that enables you to delay paying Capital Gains Tax (CGT) on a property when you transfer it to a limited company in exchange for shares. The delayed CGT on the property does not have to be paid until you sell the shares.
How does Incorporation Relief work?
When transferring your property portfolio to a limited company in exchange for shares, you may be eligible to delay paying CGT on the properties until you sell the shares. This temporary relief (known as Incorporation Relief) is applied immediately upon transfer and is not something you need to apply for.
The new shares in the company carry a reduced base cost for tax purposes, broadly matching the original cost of the properties. Therefore, it is important to be aware that a sale of those shares in the future could result in a higher CGT liability than anticipated.
What are the conditions for Incorporation Relief to apply to landlords?
To qualify for Incorporation Relief, landlords must demonstrate to HMRC that they operate as a business and are not just considered a passive investment.
The distinction between a property business and a passive investment is not defined, but the size of your portfolio and how actively you manage it are key factors. If the portfolio qualifies as a business, transferring it to a limited company can delay CGT on the properties. However, you will still need to pay SDLT unless the transfer involves a partnership.
What are the conditions of a partnership in relation to SDLT and Incorporation Relief?
A partnership involves two or more people in a business and may be incorporated into a limited company without triggering SDLT. To qualify for Incorporation Relief as a partnership, you must demonstrate a genuine business collaboration with your partner that includes sufficient ‘active’ activities beyond passive property investments.
HMRC has established anti-abuse regulations to prevent people from setting up artificial arrangements that only have tax savings as the motive. A property partnership must exist for a sustained period of time before it can be incorporated – while there is no specific timeframe, it is recommended that your partnership exists for around three years before incorporation.
Potential benefits of Incorporation Relief
There are many potential benefits of incorporation, including but not limited to:
- More tax efficient remuneration planning
- Lower tax charges when properties are sold
- No restriction to tax relief on mortgage interest
- Efficient pension planning
- Increased access to capital through the issuance of shares, facilitating business expansion and investment opportunities
- Enhanced liability protection for the business owner, separating personal assets from business liabilities and mitigating personal financial risk
- Greater flexibility in structuring the ownership and transfer of shares, which provides succession planning options and the potential for a smoother transition of the business in the long term.
Case study on Incorporation Relief for properties: Elizabeth Moyne Ramsay vs HMRC (2013)
The Ramsay vs HMRC study is a good example of how a landlord can qualify for Incorporation Relief when transferring a property portfolio to a limited company. The case established that active involvement, demonstrated by Mrs. Ramsay’s 20 hours per week commitment to her properties, satisfied the “business” test for Incorporation Relief.
In this instance, the property portfolio was considered a business rather than a passive investment, so it could be transferred to a limited company without triggering an immediate CGT charge.
The 20 hours per week Mrs Ramsey committed to her properties passed the ‘business’ test but it cannot be looked at in isolation and may be challenging for individuals with smaller portfolios to convince HMRC of their business status.
How can we help?
There are many instances where a landlord tries to transfer their portfolio into a limited company for tax savings but fails to do so successfully because of the intricacies involved and the technical knowledge of tax required. Seeking expert tax advice on this process can save you time and stress.
At PKF Smith Cooper, our expert tax team can offer guidance at any stage of your property portfolio incorporation. Get in touch with us today. Whether you have unsuccessfully tried to incorporate your property portfolio in the past or are looking to explore your incorporation options for the first time, we can help you.