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Section 24 - Death of the ‘Accidental’ landlord, or a blessing in disguise?

Friday 08 September 2017

By Tony Gimple

Most people think that politicians are dumb and out of touch, and these days it’s all too easy to see why.  Yet in my experience the dumb bit is far from true, especially when it comes to Chancellors.

Let’s take the case of George Osborne’s infamous S24 Tenant Tax.  Far from being a one-off attack, has gorgeous George set up those landlords who incorporate for an even bigger onslaught?

For example; it would be very easy for his successors to introduce a higher rate of corporation tax for property investment companies (HMRC will class you as that), in exactly the same way he did when lowering Capital Gains Tax (CGT) rates for everyone except landlords.

Either way though, it seems the government has reached the end of its tether as far as the ‘Accidental’ landlord is concerned, and it’s finally become clear that if you want to maximise your profits and legally minimise the loss to tax, then now really is the right time to become a professional property business.

Now whilst not everyone will be affected by Section 24, most landlords are generally paying more tax than the law obliges them to, both during their lives and in inheritance tax on death.

Likewise, and despite the fact that investing in property is one of the best ways of generating income and capital growth; nearly every landlord we see doesn’t have a plan that sets out their tangible goals and how to achieve them.

Whatever your personal situation, when considering your future as a landlord, in practical terms you only have four options: -

  1. Sell up. Take the CGT hit and mortgage penalties (if any), and either spend the lot or invest the money elsewhere.
  2. Decide to do nothing. Investigate the options as best you can and decide to stay as you are even though that may increase your tax bill and lower your disposable income.
  3. Incorporate. Move your personally held investment properties into a limited company to get over S24, albeit the hidden costs and restrictions will likely cripple you as shown below.
  4. Run a highly tax efficient professional property business to achieve your life and wealth goals...

If you do nothing of course, Section 24 will bite, and the extent of the chunk removed from your wallet will depend on your new level of taxable profit. Do nothing, and your taxable profit will increase by the amount of financing costs that you are no longer able to claim as an expense:

TaxYear % of finance costs deductible from rental income % of basic rate tax reduction
2017 to 2018 75% 25%
2018 to 2019 50% 50%
2019 to 2020 25% 75%
2020 to 2021 0% 100%

By 2021 then, whilst your taxable profits will have increased by 100% of your finance costs, your real post-tax profits could be significantly lower than they are today, due to a higher tax bill.

It’s important to note however that the government are effectively providing a tax credit of 20% of your finance costs. So, if you are a basic rate tax payer, and will not become a higher rate tax payer through the increase in your pre-tax profits, then you will not be affected by Section 24 in the short term.

For most Landlords however, Section 24 is likely to bite soon, and if not by 2021 then soon after as they expand their portfolios. The result is that at first sight options 3 and 4 are the only practical choices left on the table. So, let’s look at a direct comparison:

Option 3 – Incorporation

Option 3 is in some ways the path of least resistance (most high street accountants and even some property specialists see this as the right way to go), but you should please note that we do not generally believe that full incorporation or one via a temporary LLP (used if you can’t truthfully claim S162 relief as you’re not actually working 19 hours a week or more IN the business), makes commercial sense.

This is for reasons including the following:

  • Exposure to CGT (up to 28%) and Stamp Duty (up to 15%) if you can’t prove entitlement to S162 Incorporation Relief
  • Typically requires a change of legal title (ownership) and thus a likely remortgage, with all the associated costs such as early redemption penalties, legal, broker, and lenders fees
  • There are a limited number of lenders, higher interest rates, restrictive commercial terms such as loans being repayable on demand, additional cash requirements if property prices fall increasing the loan to value, and mortgage lock-in if the lender loses their appetite. Moreover, lenders frequently take a debenture (charge) over the company's balance sheet, which means that you can't withdraw your own capital or repay directors loans without their consent.
  • Companies and individuals taxed seven ways: -
    • Corporation Tax (19% falling to 17%) Capital Gains Tax on personal withdraws of capital resulting from selling assets (10%, 18%, 28%)
    • Directors Loan Account Tax (32.5)
    • Dividend Tax (7.5%, 32.5%, and 38.1%)
    • Income Tax (20%, 40%, 45%, and 60% on the slice between £100,000 and 123,000) Employees and Employers NIC (12% and 13.8% respectively)
    • Inheritance Tax (40%)

Option 4 – Run a highly tax efficient professional property business

Rather than incorporating in what we often see as a knee-jerk reaction to Section 24, take the time to fully understand the best legal structure for your portfolio given your personal situation. 

Where it will benefit their business the most, Less Tax 4 Landlords recommends holding the current or future investment properties through a Personal Ownership / Limited Liability Partnership (LLP) / Limited Company hybrid; a recognised corporate structure and business management tool.

When properly arranged and managed, hybrid tax and property ownership delivers: - 

  • No need to remortgage or change title, thus no CGT or Stamp Duty
  • Tax from your property income at basic rate 
  • No Inheritance Tax and seamless succession planning
  • Two layers of limited liability and protection against family/marital break up
  • Maximum commercial flexibility and choice of finance

With such a structure in place then, how do you run it as a business?

First things first, a business only exists to make a profit, and not as a vehicle to save tax!

Meanwhile, a good place to start is by having a written thought through flexible business plan that starts where you want to finish, both in the short, medium, and longer term.  To do that though, you’ll first have to decide what it is you really want by answering how much, of what, by when, by whom, and most importantly, why?  By the way, it’s perfectly OK to have goals like holidays, Rolex watches, spending more time with the family, or doing good works; just as long as they’re quantified by time and money.

With this understanding, you can then plot your route from A to B, and begin to look at the best structure by which to achieve your goals.

And whilst we can’t give specific advice about which way a landlord should go until we’ve met and engaged, typically, if you want to maximise the potential to grow your net worth by truly running your portfolio as a professional property business, whilst at the same time reducing tax leakage to the absolute legal minimum, and maintaining maximum flexibility to achieve the greatest returns, then most likely you’d be best served by a hybrid structure.

Tony Gimple

LessTaxForLandlords.co.uk

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Article by:

Tony Gimple

Tony Gimple

Tony Gimple has worked for Legal & General, American Express, Towergate, Chancery Law Group and Bowling & Co Solicitors (a Leading Legal 500 firm where he was their estate planning director), and is the subject of a Cranfield MBA thesis on entrepreneurship.
 

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