One expert believes he’s found a way to pay NO tax at all…
I am a successful private landlord with a portfolio of nine properties in various cities across England but the new tax changes may force me to sell everything.
My adviser has said I should set up a limited company and ‘sell’ my properties back to myself through the company as then I will be able to claim business expenses.
I can see the sense in this but the cost of doing it is just so high.
It won’t be worth it by the time I’ve paid capital gains tax, stamp duty, legal fees and valuation fees – not to mention it means I will have to remortgage all nine properties.
I’ve thought about putting the rents up but in all honesty I don’t think my tenants will pay it – there are too many other properties available.
Doing nothing isn’t an option – the cuts in tax relief will eat into my income to such a degree I would have to sell in the next three years.
Is there anything I can do to avoid this?
This is Money says: This question is typical of those landlords are asking in the face of the forthcoming changes to mortgage interest relief on buy-to-let properties.
While currently they can offset their mortgage interest against income tax, from April 2017 they will see this benefit cut and eventually replaced by a 20 per cent tax credit.
The switch will also fundamentally change the way that landlords deal with their finances: instead of paying tax on just their profit, after 2020 they will have to pay tax on their rental revenue.
At the moment mortgage interest and other allowable expenses are added up, they are then subtracted from rental income and tax is due on the profit that is left.
In future, rental income will be added to any other income to decide a landlord’s tax rate, income tax will be due on this and a 20 per cent mortgage interest tax credit will be given.
There have been a number of suggestions on how landlords can mitigate this, largely involving owning properties through a company. This expert answer below takes that concept and expands on it, revealing a complicated way those with large mortgage debts could slash their tax.
We’ve published it to show how landlords may end up going to extremes to avoid paying more tax – not as the suggestion that they should do so.
After all, there is another important question at play here involving ethics. Should landlords have a duty to pay the tax that the system has decided is due, rather than try to avoid it?
Mark Alexander, founder of Property118 and The Landlords Union, replies: With proper planning, you could be in a position to avoid the effects of restrictions on mortgage interest tax relief.
What’s more, you may also be able to benefit from significantly lower tax rates on profits retained within your business.
The change to tax treatment of mortgage finance for individual landlords is scheduled for phased introduction from April 2017 and will mean tax relief will drop from a maximum of 45 per cent (the highest rate of income tax) to a maximum of 20 per cent by 2020.
The benefits of becoming a company
Limited companies pay only 20 per cent corporation tax on retained profits and their finance costs will continue to be 100 per cent deductible as business expenses.
Switching from one to another isn’t straight forward though – as you have clearly discovered.
Without correct planning it can result in significant costs in terms of stamp duty and capital gains tax falling due, and additional costs associated with refinancing.
However, there is legislation that allows for businesses that are incorporating to claim relief to wash out tax which would ordinarily become payable.
Partnerships can take advantage of this legislation immediately whilst sole owners would need to take a phased approach, converting to a partnership as a stepping stone towards incorporation after a minimum period of three years.
Refinancing buy-to-lets can prove to be astronomically expensive
The other major stumbling block for those landlords worst affected by the tax changes has been a perceived need to refinance, the costs of which can prove to be astronomical and may result in losing preferable mortgage terms agreed prior to the credit crunch.
However, refinancing isn’t always necessary. This is because mortgage lenders take their security against the legal interest in property whereas HMRC taxes the beneficial owner.
Ordinarily these are one in the same but it is possible to split the two the using a ‘beneficial interest company trust’.
How does it work?
A beneficial interest company trust transfers 100 per cent of the beneficial interest (income and capital gain) in a property rental business to a company.
This involves no change of legal ownership so far as HM Land Registry is concerned. The consequence is that existing mortgages can remain in place without affecting the mortgage lender’s rights.
The trust deed empowers the company to be able to call upon the legal owner(s) ‘settlor’ of the trust to sell the property at any time and transfer 100 per cent of the net sale proceeds to the company.
In reality the persons controlling the company are the same as the legal owners of the properties, hence there should never be a conflict.
Due to the way the trust deed is structured, the legal owners of the property rental business now stand as bare trustees, in other words they hold the legal title in name but don’t own any share of the rental profits or capital gains.
The settlor is still legally responsible for the mortgage arrangements.
How does the settlor receive the money to pay the mortgage interest?
Again, this is dealt with in the trust declaration. Without affecting any of the legal rights of the mortgage lender, the trust deed makes the company a party to the mortgage liability, and hence responsible for servicing the contracts.
The structure allows the settlor of the trust (the legal owners/borrowers) to continue to make the mortgage payments and claim them back from the company.
The outcome is that the entirety of the business sits on the balance sheet of the company and all income and expenses associated with the property portfolio accrue to the beneficial interest company trust.
This leaves you with a zero tax liability based on the ability to claim 20 per cent tax relief on the mortgage interest.
HMRC has the right to treat payment of the mortgage as income arising to the settlor of the trust. However, the settlor of the trust (as bare trustee) would only be responsible for the flat 20 per cent tax rate payable by trustees.
This leaves you with a zero tax liability based on the ability to claim 20 per cent tax relief on the mortgage interest.
There is no one size fits all strategy however and I would say it is highly advisable for you and all landlords to seek advice on such matters from fully qualified and insured legal and tax professionals.
Planning of this nature is unlikely to be financially viable for landlords with less than £1million of mortgage debt as professional fees typically range from £14,000 to £28,000 plus VAT.
On the flip side, the greater the levels of mortgage borrowing, the more advantageous planning of this nature becomes.
