Changes in the last few years have transformed the tax landscape for residential property ownership in the UK. How should this affect your choice of acquisition vehicle?
A wide variety of taxes apply at different stages of property ownership. These are Income Tax, Stamp Taxes (SDLT), Corporation Tax, Inheritance Tax (IHT), Capital Gains Tax (CGT), VAT and Annual Tax on Enveloped Dwellings (ATED).
There are many ways to structure a property purchase. We look at three principal vehicles for holding a property: in your own name, through a company, or through a trust.
This is the simplest option and may also be the most cost effective for raising finance. Generally, banks are happier lending to individuals than to companies, and often at lower rates.
On purchase, SDLT rates are up to 15% for UK residents or 17% for non-residents. The respective bandings are wider at the lower rates of SDLT, meaning that the rate tends to be lower than for company ownership.
Rental income is subject to tax at the owner’s marginal rate of tax (i.e. between 0% and 45%). In many cases, exposure to the top rate of Income Tax on property rental profits will be enough to discourage investment in UK real estate.
Expenditure wholly and exclusively related to the rental business, including maintenance and finance costs, may be deductible to reduce the total tax payable on rent. Under new rules, restriction to interest relief on residential properties means that relief for finance costs is limited to the basic rate of Income Tax (20%). This is a major drawback when compared to corporate ownership, as we explain below.
If you lived in the property you may be able to claim Private Residence Relief (PRR) for the period of occupation and for certain periods of non-occupation.
Special rules apply for disposals by non-UK tax residents, where the base cost may be uplifted to the value at April 2015. For more information on individual disposals please see our insight.
On an individual’s death, UK-situs assets (which include UK residential property) will form part of the deceased’s UK estate. These will potentially be subject to UK IHT at 40%, after taking into account the IHT nil rate band of £325,000. If you hold a property in your own name and leave it to someone else on your death, the CGT value of the property for the new owner would be reset on your death.
As with individual ownership, on purchase SDLT rates could be up to 15% for UK residents or 17% for non-residents.
The main attraction of holding property in a company is that rental profits are subject to Corporation Tax at 19% (increasing to 23% from April 2023) rather than Income Tax of up to 45%. However, during the lifetime of the company the most common way of extracting profits is by way of dividends. This means that the aggregate tax payable on profits received by a shareholder via a company will be higher than if the profits had been received directly. Alternatively, the company could be set up by way of a loan, and repayment of this loan could be a tax efficient way of extracting profits.
In a similar way to individual ownership, income expenditure associated with the property may be deductible to reduce the total tax payable on rent. But unlike personal ownership, there are no restrictions and the full element of mortgage interest is deductible from the landlord’s taxable rental income – provided that the borrowed funds are applied “wholly and exclusively” for the property business and that the interest is “not excessive”. This is a major benefit compared to personal ownership.
One drawback of owning UK residential property via a corporate structure is the ATED requirements (for more on this, please click here). But if the property is used for business purposes (i.e. letting or property development), there should be no ATED charge.
Disposals of the property are subject to Corporation Tax on gains at a rate of 19% (increasing to 23%). Unlike direct ownership or ownership via a trust, PPR cannot be claimed to reduce the gain.
Residential lettings are exempt from VAT. But serviced accommodation is not exempt, as it is treated as holiday accommodation and therefore standard rated.
New residential development is zero-rated. This means you can claim back the VAT you paid to suppliers for the development work. But the rules around this are quite complicated, and we recommend you seek advice first.
For individual gains on the disposal of the company’s shares (on the basis that it is treated as a property rich company, i.e. which derives 75% or more of its gross assets value from UK property) the rate of tax is either 10% or 20%. The indirect disposal must be reported within 60 days.
Another consideration when selling the property is that the purchaser may be more attracted to buying the shares in the property holding company, as the SDLT rates are considerably lower (0.5% compared to 17%).
Following changes made to the UK IHT provisions in April 2017, shares in closely controlled non-resident companies which derive their value from UK residential property are subject to UK IHT at 40% on death. A closely controlled company is one which is broadly controlled by five or fewer shareholders. Note, too, that loans made to such companies to acquire, improve or refurbish UK residential property will also be subject to IHT.
The transfer of UK residential property into a trust may give rise to an IHT charge of 20%. There may also be CGT implications. In certain circumstances, where the settlor is non-UK tax resident and the assets transferred into the trust are non-UK situs assets (i.e. cash held abroad), the 20% initial IHT charge can be avoided, however, for income tax purposes the transfer of assets abroad provisions may need to be considered.
Once the assets are held within the trust and the settlor cannot benefit from the trust, they may not be part of the settlor’s estate and therefore not subject to UK IHT at 40% on the death of the settlor.
UK situs assets held within the trust may be subject to IHT at a maximum of 6% on the trust’s 10-year anniversary (periodic charge) or when the property is distributed out of the trust (exit charge).
The SDLT rates charged when a trust acquires a property may also be up to 15% for UK residents and 17% for non-UK residents.
Trustees owning UK residential property are subject to UK CGT on realised gains. The rate of tax will be 28%.
Capital gains from disposing of property rich companies are subject to tax at 20%.
Generally, trustees are liable for Income Tax at 45% on rental profits. But this could be reduced to 20% at trust level if a life interest in the income is granted to a beneficiary.
Subject to the trustees’ agreement, any income distributed to a beneficiary will have a 45% tax credit attached, which may be reclaimed by the beneficiary if they are not a higher rate taxpayer.
Special rules apply for settlors who could benefit from the trust.
The decision whether to hold property directly, via a company or through a trust is not necessarily a straightforward one.
Personal ownership may mean lower rates of SDLT on purchase, avoiding an ATED charge during ownership, and may exclude any capital gain on a sale or gift if the property is to be your main residence.
But there are circumstances where trust or corporate structures are more suitable and offer certain benefits. For example, for property rental, development or trading, your business may benefit from being held in a company. This is primarily because of the difference in rates between Corporation Tax and personal Income Tax. Company ownership can be advantageous where limited liability is required. And there may also be non-tax reasons to hold properties through a trust, such as confidentiality, estate planning and asset protection.
