14 Apr 2020 Guest post by Mark Alexander of property118.com
Taking professional advice on the optimal ownership structure for UK landlords is arguably the most overlooked aspect of their financial planning.
It is probably fair to say that most landlords do a fair amount of research when buying properties to consider the potential for capital appreciation and cashflow. They also research the mortgage market for the best mortgage deals if they intend to finance their properties and many also consider letting and management.
However, when they think they have got all these ducks in a row they then proceed to make the acquisition with little or no regard to the optimal ownership structure. In many occasions, they repeat this for years or even decades until they find themselves in a mess.
In fact, I would go as far as to suggest that most people simply choose an ownership structure based on the convenience of financing, with little (if any) thought beyond that. For example, they might just buy in their own name, or jointly with a spouse, family member or a friend. More recently, since legislation began to restrict finance cost relief for individual landlords, higher rate tax-payers often take advice from their peers on Social Media to buy within a Limited Company, but then buy a company ‘off-the-shelf’ for around £100 and think that will be fine. In most cases, it isn’t!
The Property118 tax team also regularly come across scenario’s where people have multiple ownership structures. More often than not, this is driven by historic availability of financing or whatever seemed logical at the time.
When the Property118 team of tax consultants review a client’s existing ownership structure, with a view to advising on what the optimal structure should be, the starting point is to understand what their objectives are. The common reasons given are:-
- To build a retirement fund for their old age. In this scenario they often plan to reinvest rental profits and increase mortgages, when capital appreciation and rental growth allows, to raise deposits towards further properties.
- To create a legacy for their bloodline for future generations
- To provide immediate cashflow, sometimes for themselves and occasionally to fund specific objectives such as school fees planning or further education costs
A very common thought pattern is that landlords will plan to build a large portfolio on the back of finance pre-retirement with a view to selling off enough properties to pay down mortgage post-retirement in order to be left with a smaller portfolio to manage with very little or no mortgage debt.
However, what they fail to plan for are the two certainties in life – death and taxation, i.e. income tax, capital gains tax and eventually inheritance tax.
One of my favourite sayings, which is often accredited to Confucius, goes something like this – “the best time to plant a tree was 20 years ago, the second best time is now!”
What I take from this is that the best time to organise the optimal ownership structure for your property rental business was when you started it. However, if you fall into the 99% of people who didn’t do that, the second best time is now.
So what is the optimal business structure for UK landlords?
The answer to this questions is; there isn’t a ‘one-size-fits-all’ ownership structure.
This is because everybody’s objectives are different.
The optimal structure might also evolve, because people’s circumstances change.
An important consideration for all landlords is the increasingly litigious nature of society and the ever increasing amount of legislation that landlords are compelled to comply with. I believe there are now 181 different such pieces of legislation , and that is assuming I have not overlooked any of them, which is a very worrying thought! The ability to ‘ring fence’ personal assets from these potential rental property business liabilities is now more important to consider than ever before.
Today, the best structure might be an LLP, especially for people whose current objective is to allocate rental profits between several adult family members in order to take full advantage of their lower rate tax bands. Remember, tax is based on allocated profits within an LLP, not on drawings. Accordingly, an LLP can be incredibly tax efficient from an income tax perspective but can also be used for inheritance tax planning. A good example of this can be found in an article I published which explained how a landlord managed to reduce his income tax bill by 85% and at the same time make inheritance tax provisions by using an LLP structure. View the article here.
Properties can be held on trust for an LLP, so existing financing need not be affected. This means that Members of an LLP can continue to obtain financing in the personal names of any one or more its Members. You may have noticed that many Solicitors and Medical practices now operate as LLP’s. Several of these have more than four Member/Partners, but it is only possible for up to four people to be registered as owners of property at HM Land Registry. This is why the ability for individual members to obtain financing and hold property ‘on trust’ for an LLP is allowed, because it is a practical solution to this problem.
In other circumstances, a Limited Company could be the optimal ownership structure for UK landlords, but very rarely within a £100 ‘off-the-shelf” company.
Serious thought should be given to whom the founders of the company wish to leave their shares to when they die. There is no business property relief available to property companies, so on death, the value of the shares go to the estate of the deceased for inheritance tax calculation purposes. For this reason, it often makes sense for the founders of the business to loan seed capital to the company and withdraw that from company profits (no income tax payable) to service their lifestyles before declaring high salaries and dividends.
The growth in value of company shares can be capped by the founders by converting them into Freezer Shares. They maintain all voting and dividend rights and then leave these shares in their Will. Bear in mind that their shares are would then have minimal value for inheritance tax calculation purposes, especially if they have withdrawn all seed capital from their business prior to their death.
A second class of shares can then be created with no automatic dividend or voting rights and only a nominal value. These shares can be gifted whilst they are almost valueless. Once this has occurred, they can be re-classified as Growth shares, i.e all future growth in the capital value of the company accrues to those shares on dissolution of the company. The benefit of this is that any future capital growth in the company accrues outside of the estate of the founders.
A strategy often recommend by the Property118 tax team is to gift those ‘Growth Shares’ shares to a Discretionary Trust, to ensure the legacy of the founders continues to benefit their bloodline and is safe from attack if the beneficiaries of their spouses divorce them. The way this works is that a ‘letter of wishes’, which is addressed to the trustees of the Discretionary Trust, is drafted in such a way so as to ensure that only nominated beneficiaries and their bloodline can benefit from the trust. Also, and very importantly, the letter of wishes states that the value of the trust is only ever distributed in the form of loans to beneficiaries, repayable on the death of the beneficiary. These loans, whilst they are outstanding, also accrue interest at 2% a year, with a view to the legacy keeping place with the Bank of England annual inflation target. However, interest is not serviced, rather it is rolled up until repayment or the death of the beneficiary. There are good reasons for this, which are made clear from the examples below.
A practical example of a Discretionary Trust strategy
- One of your beneficiaries gets married and wants to buy a house.
- The trustees agree to make a loan of say £500,000 to help with this.
- Your beneficiary and spouse then have children.
- However, after a few years the couple decide to get divorced.
- The spouse wants half of the value of the house, which the Courts may well agree should be the case, but the debt to the trust, plus accrued interest, needs to be factored into the settlement figure.
- If necessary, once the loan is settled, it is then provided again to the intended beneficiary.
Years later, the beneficiary dies and his/her assets are valued for probate purposes. Yet again, the debt to the trust needs to be factored into the net value of the estate, not forgetting the accrued interest of course. This serves as financial salvation to their bloodline!
Naturally, a structure of this nature also needs to dovetail with your Last Will and Testament.
There isn’t a ‘one-size-fits-all’ ownership structure.
The above is just a flavour of what can be achieved. It is most certainly not to be taken an an alternative to taking professional advice from the Property118 Tax team.
The purpose of this article is to show you that owning property in personal names or in a £100 ‘off-the-shelf’ Limited Company is very rarely the optimal ownership structure for UK landlords
If you feel trapped in your existing ownership structure, please don’t. There is plenty of legislation to assist businesses to evolve, without incurring unfair taxation. For example, there is no capital gains tax or Stamp Duty when people transfer their rental properties into an LLP structure, providing their existing equity flows into their opening capital account balance. Likewise, incorporation reliefs often apply to mitigate Stamp Duty and capital gains tax when a property rental business transitions into operating within a Limited Company structure.
We hope the above has provided you with the necessary inspiration to take action now by seeking professional advice from the Property118 tax team on the optimal ownership structure for your property rental business.
Property118 does not provide accountancy services at all, which is why we always recommend involving your accountants in our discussions at an early stage of the consultation process. Our role is to help you to understand what is achievable in law, and to assist you with the legal matters associated with implementation if you wish to follow our recommendations. This is a service that accountants seldom provide. Their primary focus is on keeping you compliant with HMRC and accounting for optimal taxation within your existing ownership structure.
Landlord Tax Planning Consultancy is the core business activity of Property118 Limited (in association with Cotswold Barristers).
For your own peace of mind, please note that advice of this nature, from a Barrister-At-Law is backed by his Professional Indemnity Insurance of £2,500,000 per claim. In addition, he is confident enough in the robustness of the strategies that he will represent you at no extra cost in the event of any HMRC or lender challenge.
About the Author of this article
Mark Alexander has been a portfolio landlord for 31 years and worked in property, finance, tax and law for 34 years.
Since 2009 he has gradually been doing less work and selling property in order to enjoy a much better retirement. That was always his plan.
He achieved financial independence in 2003 and by 2008 one of his companies ranked at #38 in The Sunday Times Profit Track 100.
He was a founder of the NACFB and also Property118.
He was also a non-exec Chairman for a Barristers Chambers until a few years ago.
His speciality is landlord tax and has published numerous articles on this subject.
For more information please see www.Property118.com/Tax