What can we do about latent gains in our rental property portfolio?

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19:26 PM, 30th May 2017, About 8 years ago 1

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My wife and I want to incorporate our buy-to-let portfolio but our outstanding finance is £600,000 more than the purchase price and capitalised costs associated with the properties. From a tax perspective it seems we could be far better off if we incorporate, especially in a few years time when the restrictions on finance cost relief really start to bite.

We believe we qualify for incorporation relief but our understanding of how that works is that we will exchange equity for shares and the value of those shares will be applied to offset our capital gains. The problem is that our equity is £600,000 less than our capital gains. This leaves us with £600k we can’t get relief on and will result in 28% of that £600K falling due in CGT unless we can find a way around this problem.

Has anybody else had a similar problem and found a way around it?

Thanks

Bobby

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Mark Alexander - Founder of Property118

19:42 PM, 30th May 2017, About 8 years ago

Hi Bobby

Presumably you are not in a position to pay down the mortgages by £600,000 without selling properties and incurring CGT?

Are you both higher rate tax-payers? If not, you should at least look into forming a partnership with your spouse and allocating profits to take both personal incomes up to the basic rate income tax ceiling. This is currently £45,000 and is scheduled to increase to £50,000 by 2020. If your taxable income does not exceed these figures incorporation may not be necessary.

Do you have any adult children who could also become partners in the business?

Do you own your own home and if so what is its value and outstanding mortgage balance?

Do you have any close friends or relatives who own a rental property portfolio?

OTHER POSSIBILITIES

If you have other family members or friends who do not have latent gains issues (i.e. their mortgages are substantially below their base costs) you may wish to consider discussing the formation of a partnership with them. This might then remove the latent gain issue across the portfolio and make incorporation more viable. However, such an arrangement would fall foul of HMRC’s GAAR legislation (General Anti Abuse Rules) if you were to incorporate the partnership within three years, so you would need to wait as least that long. The advantage to the incoming partners would be to benefit from incorporation themselves, i.e. lower tax and washing out capital gains to date.

You could also consider moving offshore, ideally to a Country which doesn’t charge capital gains tax (perhaps Malta which is where I live, partly for this very reason!). This might not remove the CGT element completely but you would then only pay CGT on capital gains made since April 2015 on any properties you sell or incorporate.

Another opportunity to remove the latent gains problem may exist if you have substantial equity in your own home. You could either remortgage that property to pay down your BTL properties or move out of the property, add it to your BTL portfolio for rental and buy or rent another home elsewhere. That's what I did. My latent gain occurred due to me having to remortgage my portfolio to pay off a divorce settlement.

You could form a company to manage the properties, which would then charge the partnership up to 15% management fees. The advantage of this is that the company would only pay corporation tax, which is at a much lower rate that higher rate personal income tax. You and your wife could take £5,000 of tax free dividends from that company this year and £2,000 a year of tax free dividends thereafter. The remaining money could be retained in the company to a point when your personal taxable incomes fall below the basic rate tax threshold, or indeed these profits could be used to purchase additional properties within the company.

I hope this helps.

To book a Private Consultation please see the link below.

https://www.property118.com/optimal-tax-planning/91857/
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