Residential property portfolios: three ways to help with income tax planning
Since April 2017, when legislation changes were made to tax breaks on buy-to-let property, the yield has no longer as attractive as it once was. As a result, some landlords with just one buy-to-let have – or are – deciding to sell, avoiding the strategy altogether.
Historically, finance costs were fully tax deductible for the owner. However, this is in the process of being restricted to basic rate income tax only. With the nature of the property sector being ‘illiquid’, selling a property isn’t straightforward. Therefore, retaining the asset – and implementing a strategy to ensure the income generated is tax-efficient – is high on the agenda for many.
There are various strategies to try and reduce the tax bill, of which we’ll look at three.1) Transfer of income/ownership
For husband and wife cases, it is worth reviewing the income tax position of each individual. If the buy-to-let property is in the name of the higher earner, it may be a good idea to transfer ownership to the other as to utilise their personal allowance, or pay tax at their marginal rate (if a basic rate tax payer).
For example, say the wife is a higher rate taxpayer, so is subject to tax at 40%, while the husband is paying 20% as a basic rate taxpayer. If the buy-to-let is in the wife’s name, transferring it to the husband would ensure the income is taxed at 20% rather than 40%, providing all of this falls within his basic rate tax band.
The transfer would be exempt for both inheritance tax (IHT) and capital gains tax (CGT), as this would be classed as an inter-spouse transfer.
Related is the transferring of a property portfolio over several years into a limited company. However, the CGT and stamp duty land tax position needs to be taken into account.2) Venture capital trusts
Venture capital trusts (VCTs) were introduced in 1995 by the Government to encourage private investors to invest in small UK trading companies while benefiting from substantial tax benefits. As investment into VCTs provide 30% income tax relief (to a maximum of the income tax paid) of the initial investment amount, they can be a useful tool to reduce any income tax liability generated through the property rental income.
Other advantages of VCTs include tax-free dividends, tax-free gains upon disposal, and the ability to invest up to £200,000 per tax year. The points to consider with VCTs, are that the investment must be held for five years to retain tax relief, and it will be illiquid for that five years. They’re also deemed higher-risk investments.3) Enterprise investment schemes
For more than 20 years, enterprise investment schemes (EIS) have been helping smaller companies raise finance by offering generous tax relief to investors. Similar to VCTs (and again higher risk), the income tax relief available upon investment – 30% – can be advantageous, and this time, it only needs to be held for three (albeit illiquid) years to be retained; gains are also exempt from CGT after this period of time.
Clients can invest up to £1m per tax year, with the facility to invest another £1m providing this is made into knowledge intensive companies. Also, the investment qualifies for business relief once held for two years, meaning no IHT is payable on the amount.Summary
The above planning scenarios won’t be applicable to all individuals, yet, they provide some options for those affected by the changes in legislation. As each individuals’ position will be unique, it is important to seek advice from a financial adviser.
Additionally, residential properties could be subject to IHT upon death. Therefore, this is another important point to consider.