Why landlords consider incorporating: Section 24 and corporation tax
The Section 24 finance cost restriction (Income Tax Act 2007 s.272A) prevents individual landlords from deducting mortgage interest fully from rental income — relief is limited to the basic rate (20%). A limited company owning rental property is NOT subject to Section 24 and deducts full mortgage interest. Combined with corporation tax rates of 19-25% vs income tax at 40-45% for higher-rate payers, the ongoing tax saving for a highly-geared, higher-rate landlord can be significant. However, the one-off transaction costs of incorporation frequently exceed the projected tax saving for many portfolios.
SDLT obstacle: transfer to connected company at market value
- FA 2003 s.53: when property is transferred to a connected company (one controlled by the transferor — Corporation Tax Act 2010 s.1122), SDLT is calculated on the higher of actual consideration and open market value — even if no cash changes hands and the landlord simply contributes properties in exchange for shares
- 3% SDLT surcharge: the additional dwelling surcharge (3%) applies to every residential property transferred to a company
- Example: £300,000 property — approximately £14,000 standard SDLT + £9,000 surcharge (3%) = approximately £23,000 SDLT per property
- Multiple Dwellings Relief (MDR): ABOLISHED for transactions completing on or after 1 June 2024 (Finance Act 2024 s.11) — no longer available to reduce SDLT on portfolio transfers
- Partnership route (FA 2003 Schedule 15): previously used to access lower SDLT treatment; HMRC has challenged these schemes; very restricted for residential property portfolios — specialist advice required before attempting any SDLT planning
CGT obstacle: disposal at market value and incorporation relief (s.162 TCGA)
- TCGA 1992 s.18: a transfer of property to a connected company is treated as a disposal at open market value for CGT purposes — regardless of the actual consideration received; if the property has increased in value since acquisition, CGT is payable on the gain
- CGT rates on residential property from 6 April 2024: 18% (basic rate taxpayers); 24% (higher/additional rate taxpayers)
- Incorporation Relief (TCGA 1992 s.162): defers CGT when a 'business' is transferred to a company in exchange for shares — the gain rolls into the base cost of the shares rather than crystallising
- HMRC's position on s.162 and BTL letting: a passive property letting portfolio is an investment, not a business — incorporation relief is NOT available; the 2013 Upper Tribunal decision in Ramsay v HMRC UKUT 0226 (TCC) held that actively managed lettings could qualify as a business under s.162, but this is fact-specific; landlords who manage their portfolio entirely through a letting agent are much less likely to qualify
- Specialist tax advice and HMRC clearance should be obtained before relying on s.162
Mortgage complications and Scotland/Wales transaction taxes
- Most BTL mortgages prohibit transfer of the mortgaged property to a company without the lender's consent — consent is almost never given; the personal BTL mortgage must be repaid and the company must obtain a new company BTL mortgage
- Company BTL mortgages: typically 0.25-1.5% higher interest rate; personal guarantee from director/shareholder required; stricter minimum property value and rental yield criteria; fewer lenders in the company BTL market
- Additional transaction costs: legal fees (title transfer to company); Land Registry fees (property registration in company name); early repayment charges on existing personal BTL mortgages; company BTL mortgage arrangement fees
- Scotland (LBTT + ADS): Land and Buildings Transaction Tax is charged on company purchases; the Additional Dwelling Supplement (ADS) at 6% (from April 2024) applies to companies acquiring residential property — this applies in addition to standard LBTT rates
- Wales (LTT): Land Transaction Tax applies; Higher Residential Rates (HRR) apply to company purchases of residential property — rates set by the Welsh Government and revised periodically
When does incorporation make financial sense?
- Most financially beneficial when: the landlord is a higher or additional rate taxpayer (40-45% income tax); the portfolio is highly geared (high mortgage debt relative to value — Section 24 costs most); the landlord intends to hold the portfolio long-term through the company (maximising the compound benefit of retained profits at corporation tax vs income tax rates)
- Less beneficial or not beneficial when: small portfolio or low rental income; low mortgage leverage (low Section 24 impact); landlord is close to retirement or planned to sell within 5-10 years (transaction costs may not be recouped); portfolio contains properties with large unrealised gains (CGT crystallisation is very costly if s.162 unavailable)
- Total transaction costs check: before proceeding, calculate SDLT + CGT (if s.162 unavailable) + legal fees + mortgage arrangement fees + ERC (early repayment charges) as a percentage of portfolio value; compare against projected annual tax saving; divide transaction costs by annual saving to find the 'payback period'
- Typically: break-even period of 7-15 years for a high-geared portfolio of modest size — portfolios with total transaction costs exceeding 10% of portfolio value often do not recover costs before the landlord exits