Incorporating a Property Partnership into a Limited Company
Written by
Ray Coman
In broad terms, incorporating a property-letting partnership means swapping more efficient tax on rental income for potentially worse tax on eventual capital gains. Simplifying succession and saving tax can be drivers for the transfer of residential or commercial property owned by a partnership structure into a company. However, there are various pitfalls which would weigh against the decision and should be reviewed from the outset, including CGT, SDLT, VAT and IHT. This guide sets out those implications by considering the key taxes in turn and indicating when incorporation tends to suit portfolios focused on long-term rental yield rather than anticipated capital growth.
Capital Gains Tax (CGT) on incorporation
Incorporation Relief (s.162 TCGA 1992)
Income Tax and Ongoing Profit Extraction
Capital Gains Tax (CGT) on eventual disposal
Capital Gains Tax (CGT) on incorporation
A transfer to a connected company is deemed to occur at market value, creating a potential chargeable gain. For example, a property with a market value of £500,000 at the date of transfer that was originally purchased for £350,000 would give rise to a gain of £150,000. This gain would be immediately chargeable to the individual owner or, in the case of a partnership, to the owners in proportion to their partnership share. Each partner may claim the annual exemption and offset brought-forward capital losses. Tax payable on the gain can be viewed in the report on capital gains tax.
A cash-flow drawback arises where CGT is payable within 60 days of completion even though no cash has been generated by the transfer to an associated company.
Incorporation Relief (s.162 TCGA 1992)
Relief can defer the gain by rolling it into the base cost of the new company shares. However, this type of incorporation relief only applies if the partnership carries on a trading business. A property-letting partnership is generally classed as an investment business, not a trade, so incorporation relief does not apply.
Where a trading element later develops (for example, operating serviced accommodation), relief may become available at that later point. For the partnership to qualify as trading, it would need to actively manage a property portfolio with its own staff and regular trading activity, or have the property used directly in carrying on a trading business. If such a change were made, for example if the property were used in a business run by the owners, incorporation relief could potentially apply at that point.
Most property-letting partnerships will trigger an immediate capital gain on incorporation.
Stamp Duty Land Tax (SDLT)
Transfers between connected parties are chargeable to SDLT based on market value, even when no money changes hands (FA 2003 s.53). The rate of tax payable can be reviewed in the table for Stamp Duty Land Tax.
If the property is opted to tax, SDLT is calculated on the VAT-inclusive figure. Revoking the option may reduce SDLT but would prevent future VAT recovery and is rarely practical.
Any SDLT paid on incorporation becomes part of the company’s acquisition cost for future CGT calculations.
If the partnership operated an ongoing property investment business rather than simply holding one or two properties passively, SDLT relief might be available.
VAT
Residential property is VAT-exempt and therefore no VAT is payable on the transfer. Certain types of commercial property have an option to tax. Where the partnership has opted to tax, the transfer normally triggers output VAT at 20% on market value. An option to tax is only applicable for commercial properties.
If the company will continue to make taxable lettings, it can reclaim this VAT on its first return, creating no net cost, though there may be a short-term cashflow effect.
In most cases the transfer of a property which is actively being rented will not be subject to VAT because the property business would be treated as a Transfer of a Going Concern (TOGC).
Inheritance Tax (IHT)
Company ownership converts real property into shares, which can then be gifted gradually to family members. Each transfer of shares is a Potentially Exempt Transfer (PET) and becomes exempt if the donor survives seven years.
Alphabet share structures allow the founder to retain control while transferring economic value. However, where the donor continues to benefit or control income, HMRC may regard the arrangement as a Gift with Reservation. Business Property Relief is not available for companies mainly engaged in property investment, so long-term gifting remains the main IHT strategy.
Income Tax and Ongoing Profit Extraction
After incorporation, rental profits are subject to Corporation Tax (currently 25%). Funds withdrawn as dividends are taxed separately, often producing a lower overall rate than partnership income subject to income tax and national insurance.
Where the ultimate beneficial owner of the property owns part of it, it is possible for that person to save tax by withdrawing the equity as loan repayment. It is typical for a director’s loan to be created to account for any equity in the property. Equity in this context is the difference between what the property is worth and what is borrowed against it. When the company starts generating rent, the cash inflows can be withdrawn as repayments of that loan.
Remaining profits can be retained in the company and taken later, either as dividends in years when income is lower or as a capital distribution on winding up the company. A faster method of extracting accumulated profits, as explained above, is via a capital distribution. However, this requires the company to be liquidated and is practical only if the owner is ready to dispose of the company-owned property.
This is a key reason why it is often recommended to have one property per company: the company can be dissolved on the sale of that property without affecting other holdings.
There is no restriction on tax relief for a loan borrowed in the company’s name. Borrowing in a company often results in less favourable lending terms, because lenders take greater risk due to limited liability. Even so, the extra cost of borrowing is often offset by the broader availability of tax relief, because interest can be deducted in full from taxable profits.
Capital Gains Tax (CGT) on eventual disposal
While company ownership can reduce the ultimate owner's exposure to tax on income, it can increase the exposure to tax on any capital gains. This is because any gain on disposal would be subject to corporation tax, and the retained profits would then be subject to tax when distributed to the company owner, either as dividends or as capital on winding up the company.
This “double tax” effect results in higher tax on any future capital gains compared with continuing to hold the property in the partnership. The likely lower tax on rental income through company ownership must therefore be balanced against the potential capital gains tax drawbacks on eventual disposal.
In broad terms, company ownership tends to be more suitable for properties that generate steady income or are held for the longer term, whereas private or partnership ownership is generally more tax-efficient where significant capital growth is anticipated.
Summary
Incorporating a property-letting partnership can improve income tax efficiency and succession flexibility, but it normally crystallises both capital gains tax and SDLT. A company set-up can reduce exposure to tax on income generated from a property, but increase exposure to tax on any gain on eventual disposal. In practice, incorporation tends to suit portfolios held for long-term rental yield; where substantial capital growth is expected, keeping the properties outside a company is often more tax-efficient overall.
Coman & Co advises landlords and family partnerships on property structuring, inheritance planning, and tax-efficient succession. To discuss a prospective incorporation or obtain a tax modelling quote, please contact us to arrange a free initial meeting.
