Setting up a property company as a Partnership

Whether or not an individual is a member of a partnership depends on facts. Simply letting jointly owned property does not constitute a property partnership. However, landlords may jointly own properties as part of a partnership business when:

• There is a significant amount of business activity involved.
• The partnership is organised similarly to 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 according to their profit-sharing arrangement rather than based on their ownership share of the property being let. This is particularly beneficial for property owned by married couples, as profits can be distributed in the most tax-efficient manner rather than being split 50:50.

Rental losses generally cannot be offset against a taxpayer’s other income because the business does not engage in a trade. However, if the partnership incurs a loss through capital allowances, these may be claimed against the partner’s other income via a sideways loss claim.

Capital Gains Tax

Partnerships are treated as transparent for Capital Gains Tax (CGT). Typically, any profit from the sale of a property will be allocated to the partners in line with their profit-sharing arrangement. Partners can claim an annual allowance (£12,570 for 2024/25) against their share of any capital gain, potentially reducing or eliminating the tax due.

Incorporating a partnership

A “Property Company” offers a useful tax planning tool for landlords who are higher-rate taxpayers. Higher-rate taxpayers (those earning above £50,270) pay income tax at 40% on rental profits and may be subject to CGT at 28% on eventual sales. In contrast, companies pay tax at more favourable rates, rental profits and capital gains can be taxed at just 19%.

However, there are several obstacles that prevent most landlords from incorporating their current property portfolio:

• The transfer of properties into a company is considered a sale at market value, which may trigger a large CGT charge if property values have increased since purchase.
• Stamp Duty Land Tax (SDLT) may also be payable on the transfer of properties into the company if there are 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 when a “property business” transfers rental property to a company in exchange for shares. This means the CGT on the transfer of properties from a property partnership to a limited company can be deferred until the shares in the company are disposed of.

Additionally, SDLT can be avoided when property is transferred from a partnership to a limited company, provided:

1. The partners are connected (family members).
2. The ownership of the newly formed company is in the same proportion as in the original partnership.

Further tax benefits

As mentioned earlier, rental profits generated within the company will be subject to corporation tax (as little as) 19%, a much lower rate than the 40% income tax rate for higher-rate taxpayers. Furthermore, the properties introduced into the company at market value will form the new base cost for CGT purposes. Therefore, when the properties are eventually sold, the company will only pay CGT on the difference between the sale price and the market value at the time the properties were introduced to the company.

What About Capital Gains Tax When Disposing of Shares?

It’s true that there will be a CGT charge when you dispose of your shares. However, in the future, the company could shift its focus to an activity classified as a trade by HMRC. For example, if the company disposes of its investment properties, it could then focus on generating income through property management or property development.

Provided the company engages in what HMRC classifies as a “trade” for at least 24 months, the shareholder may qualify for Entrepreneurs’ Relief upon disposing of their shares. Entrepreneurs’ Relief allows the shareholder to pay CGT at just 10% on the sale or closure of the business, providing a significant tax advantage to investors.