Is holding your buy-to-let property in a “Hybrid Structure” the way to go?

As of the 6th April 2017, Landlords will no longer be able to deduct all of their finance costs from their property income to arrive at their profits. Instead, they will receive a basic rate reduction from their income tax liability for their finance costs.

What does this mean for my profit?

It’s difficult to say how much more tax would be due as the reduction in mortgage interest and wear and tear allowances come to bear, but it will certainly be a hit for higher-rate tax payers. If you don’t have a mortgage or if you’re a lower rate payer, good news: you will not be affected at all.

So what are my options if I’m a higher rate taxpayer?

We recently attended an interesting talk by Tony Gimple from Less Tax For Landlords, who said, in practical terms, landlords now have four options – including holding your property in a “Hybrid Structure”. We’ve listed the options he gave for you below – and also included some FAQs at the end of the article.

  1. Sell up

The first option is to sell up and either invest your money elsewhere, save it or spend it. Yes you will have to take the Capital Gains Tax hit and mortgage penalties (if there are any), but if you are thinking of retiring anyway this could be an option.

This isn’t something that the majority of landlords will want to do right now however, as though the market is suffering a post-Brexit slump, property is still a very good bet. As we recently blogged, when compared to other asset classes, property is definitely the best vehicle for achieving wealth.

  1. Make a positive decision to do nothing

Option two is to do nothing. This will be a default decision for the majority – which is absolutely fine so long as you have explored the different options available to you and are aware of how you’ll be affected by the new tax changes.

This option will most likely mean however that your tax bill is increased and your disposable income is decreased, but it will not severely affect those with only one or two properties.

  1. Incorporate

The much touted “only way to get over Section 24”: sell your personally held investment property or properties to a limited company which you own.

Tony made it crystal clear that he doesn’t think that full incorporation, or incorporating temporarily through a Limited Liability Partnership is the best move, and we’ll explain why in the next couple of sections.

Likewise, he said that trusts are also not an effective solution, and their use for property is far more limited that it used to be. They are over-complex, especially when it comes to mortgage flexibility and inheritance tax mitigation, and generally not the best option for landlords.

What’s Section 162 Incorporation Relief?

Section 162 incorporation is available to help negate the requirement to pay Capital Gains Tax or Stamp Duty when transferring existing personally held investment properties into a limited company. You can only claim S162 if you’re ‘working in the business’, or as Tony put it, dealing with tenants and toilets yourself!

The pitfalls…

However, Tony went on to say that there are more downfalls than pros to incorporating.

Companies are great if you’re selling the whole company, as the buyer doesn’t pay stamp duty on the individual assets, only on the shares at 0.5%. If you’re disposing of individual properties, you’ve still got to pay the equivalent of Capital Gains Tax, but in this case it will be Corporation Tax which is slightly lower. A negative is that you may require the lender’s consent to use your loan account, and if they lose their lending appetite, you’ll need a new company and a new lender for every new property!

The big problem with limited companies however is getting your money out. In fact, Tony said it’s virtually impossible to take the money out of a company without paying tax at every turn, which often results in double taxation – Corporation Tax, Dividend Tax, Income Tax, National Insurance – and if it’s an investment company, 100% subject to Inheritance Tax.

  1. The Hybrid

The final option Tony gave was “The Hybrid”, which he described as ‘truly running your portfolio as a property business whilst at the same time reducing tax leakage to the legal minimum.’

This option means holding your current or future investment properties through a Personal Ownership / Limited Liability Partnership (LLP) and Limited Company mix – a recognised corporate structure.

Tony said that owning investment property this way generally offers the most balanced solution as it allows you to legally separate ownership from enjoyment from control via multiple legal personalities, so as to minimise tax insofar as the law allows and keep as much profit and legally possible. You also will not suffer the loss of mortgage interest relief or wear and tear allowances, plus tax from your property income at 20% maximum.

There were a few questions from the floor:

If I go down the hybrid route do I have to tell Land Registry?

“No – because there’s no change of title. You don’t even need to tell the lenders as there’s no fundamental breach of mortgage conditions – the lending remains in your name. We’re not using beneficial interest company trusts, it’s perfectly acceptable.”

When it comes to LLP, how do you differentiate between distribution profit and return of capital?

“It’s what you decide to call it. With LLPs or a partnerships generally, you’re allowed to once a year say we’ll distribute profit, or this year we’ll return capital. It’s up to you. The law allows you to call it either, just one will pay tax on it and one you won’t. Sometimes you will want to pay tax on it. Why? Because in two years’ time when I want to build that house and borrow a million and a half quid in my name, I’ve got to show a lender a SA302 to say that I can afford it and that it’s my money not my businesses.”

Would you have to pay Capital Gains Tax or Stamp Duty?

“In broad terms, CGT and SDLT would only arise if there were a change of title, i.e. the owner (Bill Bloggs) transfers the ownership to another legal personality (Bill Bloggs Property Holdings Limited).  As in the case of hybrid arrangements there is no change in title (Bill Bloggs still owns them), CGT and SDLT events do not occur.”

So what should you do?

Unfortunately, there’s not one right answer. If you’ve got one or a couple of properties and you’re a higher rate taxpayer, you’re going to feel a little sting from the new tax changes. But is it probably not worth getting into something complex. Instead, a better idea may be to cut your interest costs by re-mortgaging and getting an up to date rental valuation on your property. Your lender will therefore have to recalculate your LTV, and a lower LTV generally ensures a better interest rate and a larger selection of lenders.

If however you are a seasoned landlord or you want to make a positive decision to run a highly tax-efficient, professional property business, then Tony suggested you may need to start looking at how you’re going to structure it.

We strongly advise you seek independent professional tax advice before getting involved in any schemes or structures.

This Article is courtesy of Portico London Estate Agents

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