Whether or not an individual is a member of a partnership depends on facts. Merely letting jointly owned property does not constitute a property partnership.
However, Landlords may jointly own properties which are let out as part of a partnership business when:
- There is a significant amount of business activity involved.
- The partnership is organised similar to that required in a commercial business.
- The investment business is operated with a view to making profits.
The Tax Benefits
Income Tax
Rental profits are allocated to the Partners in line with their profit sharing arrangement rather than in accordance with their share in the property being let.
This is particularly useful when property is owned between married couples. Profits can be shared in the most tax efficient manner rather than being split 50:50.
Rental losses generally cannot be offset against a taxpayers other income because the business does not carry out a trade.
However, if the Partnership makes a loss by way of capital allowances, than these may be claimed against the Partners other income by way of making a sideways loss claim.
Capital Gains Tax
Partnerships are treated as transparent for Capital Gains Tax.
Typically, any profit on sale of a property will be allocated to the Partners in line with their profit sharing arrangement.
Partners are entitled to claim an annual allowance (£12,300 for 2021/22) against their share of any capital gain, meaning no or very little tax may be due.
Incorporation of the Partnership
A “Property Company” provides a useful tax planning tool for Landlords who are higher rate taxpayers.
Higher Rate Taxpayers (those who earn above £50,270) pay income tax at 40% on rental profits and are susceptible to capital gains tax at 28% on the eventual sale.
Companies pay tax at more favorable rates than individuals. Rental profits and capital gains are taxed at just 19% on profits.
However, there are a number of stumbling blocks which prevent the majority of Landlords incorporating their current property portfolio:
- The transfer of properties into a Company will take place at market value which may trigger a large capital gains tax charge if property values have gone up since purchase.
- SDLT may also be payable on the transfer of properties into the Property Company if they currently have outstanding mortgages.
A Recent Tax Case
In a recent tax case (E Moyne Ramsay v HMRC) it was accepted that incorporation relief could be claimed where a “property business” transfers rental property to a Company in exchange for shares.
This means that the Capital Gains Tax on transfer of properties from a Property Partnership to a Limited Company can be deferred until the shares in the Company are disposed of.
In addition to this, SDLT can also be avoided where Property is transferred from a Partnership to a Limited Company provided:
- The Partners are connected (family members).
- The ownership of the newly formed Company is in the same proportion as that seen in the original Partnership.
The Tax Benefits
As stated earlier, rental profits generated in the Company will be subject to corporation tax (19%) at a much better rate then that for an individual who is a higher rate tax payer (40%).
In addition to this, as the properties are introduced into the Company at market value this will form the new base cost for Capital Gains Tax purposes.
Therefore, when the properties are sold the Company will only pay capital gains tax (19%) on the uplift between the sale price and market value when the properties were first introduced to the Company.
What about capital gains tax when I dispose of my shares?
It is correct that there will be a further capital gains tax charge when you dispose of your shares.
However, in future years the Company could change the nature of its business to that classed as a trade by HMRC.
For example, if the Company was to dispose of its investment properties, it could then concentrate on generating other forms of income through Property Management or by carrying out Property Developments.
Provided the Company engages in what HMRC classes as “a trade” for at least a 24 month period, the shareholder would be able to make use of “entrepreneurs relief” on disposal of their shares.
Entrepreneurs relief allows the shareholder to pay capital gains tax at just 10% on sale or closure of the business.
This provides a significant tax advantage to investors.
If you require some specific tax advice on whether your current property business constitutes a “Property Partnership”, or if you would like to discuss the benefits of running your business as a “Property Company” please feel free to contact us for a free, no obligation initial meeting.