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Guide for landlords on forming an LLP for property investment

Guide for landlords on forming an LLP for property investment

The purpose of this article is to explain the correct process for landlords to transfer existing properties into an LLP, and some of the main advantages of doing so.

A Beneficial Interest Transfer Agreement “B.I.T.A” serves to legally document the transfer of beneficial interest in property(ies) held by one or more individuals into a Limited Liability Partnership “LLP”.

The Agreement will show the following for each property to be held ‘on-trust’ for the LLP:-

  • property address

  • market value at the point of transfer

  • finance outstanding

  • opening capital account balance for each Member (share of assets minus share of liabilities held ‘on trust’ for the LLP)

The value of the equity introduced by each member will be reflected in their individual opening capital account balances.

LLP’s are tax transparent, so there are no CGT or Stamp Duty implications unless the ownership structure is amended disproportionately to the opening capital account balances.

Legal ownership and contracts between borrower(s) and mortgage lender(s) remains unchanged.

The members of the partnership are holding the properties ‘on-trust’ for the LLP.

Members of an LLP may continue to make finance applications against LLP properties held in their own names, but any net proceeds of refinancing belong to the LLP or are otherwise treated as ‘drawings’ from the members capital account.

Members will receive an income/profit share proportionate to their capital account balance. However, disproportionate allocation of profit may be achieved by allocating certain members a ‘partners salary’ in recognition of the work they do, which could be disproportionate to their income/profit share. For example, a new member may contribute little or no equity but take on a significant share of the management of the business.

Each members profit is taxed as self-employed income. If that income exceeds £5,965 per annum they will be compelled to pay Class 2 National Insurance at £2.85 per week. However, Class 4 National Insurance is only payable if the business also engages in a trade. Property Investment alone is not a trade but is a business. As members are technically self-employed the LLP does not pay employers National Insurance, even on ‘partners salaries’

This structure is particularly advantageous where a group of individuals and/or companies wish to group together to form one business, perhaps in order to share resources, risks, experience and availability of time. There are other advantages too, as follows:-

Legacy Planning – Case Study

A family of four pool their rental property resources and experience to form an LLP. For the purposes of this exercise we will assume the members are Mum, Dad, Son and Daughter. The opening capital account balances might result in an income/profit share of 40% each to Mum and Dad and 10% each to Son and Daughter, based on the amount of equity each of them introduced into the LLP.

Now let’s assume that the ‘taxable profits’ of the business are £200,000.

Ordinarily, Mum and Dad would receive £80,000 each. As of 6th April 2019 the first £12,500 would fall within their nil rate band, the next £37,500 would fall into the 20% basic rate tax band and remaining £30,000 would be subject to higher rate tax and also trigger further tax based on the restrictions on finance cost relief to the basic rate of tax. Son and Daughter then each receive profit allocation of £20,000 each.

However, given that Son and daughter do most of the work it is agreed that Mum and Dad will allocate each of them a ‘partners salary’ of £37,500. The remaining £125,000 of profits are then allocated in accordance with profit share. In other words, Mum and Dad each receive their 40% of £125,000 which equates to £50,000 each and Son and Daughter each receive their further 10% of £125,000 which equates to £12,500 each. The outcome is that none of them are higher rate tax-payers because they all have a taxable income of £50,000. This also means they become unaffected by the restrictions on finance cost relief.

Taking this a stage further, it could also be agreed that Mum and Dad may take drawings from the business which exceeds their profit share. This is perfectly acceptable because they are withdrawing their own capital. This would result in their capital account balances reducing in value, which also reduces their IHT liability. On the other hand, the capital accounts of Son and Daughter would increase in value, on the basis that they are retaining profits they do not withdraw from the business.

Corporate members

There are three main reasons for adding one or more corporate members to an LLP. These are:-

  • To bring properties owned by an existing Limited Company under the same umbrella of the partnership, where profits and losses, income and expenses are shared pro-rata to equity

  • To enable the partnership to acquire further properties within a Limited Company structure which is unaffected by the restrictions on finance cost relief

  • To ring-fence some of the risks associated with ongoing property management

It is important to note that corporate members of an LLP cannot receive ‘partners salaries’ or profit share which is disproportionate to their ordinary income/profit share based on the value of their partnership capital account. This would fall foul of HMRC’s “Transfer of Income Streams” legislation . We advocate extreme caution when considering what is being touted as the ‘Hybrid Scheme’ which claims to be a ‘one-size-fits-all’ tax planning solution. However, corporate members may charge a ‘reasonable commercial fee’ for activities they perform on behalf of all members. For example, this might include property management or maintenance. The “Transfer of Income Streams” legislation only poses a problem where the tax system is abused, e.g. where a corporate member charges significantly more for a service than could be sourced elsewhere in the market locally. Where this is the case, the excess is taxed as if the income had never been transferred and interest and penalties on overdue tax may also apply if the tax system has been abused.

Tax Advantages of having a corporate member to provide services to the LLP

Unlike individuals, which pay income tax based on a banded tax basis, Limited Companies pay a flat rate of corporation tax (currently 19% and scheduled to reduce to 17%). Where the individual members of an LLP wish to retain profits, perhaps to save for deposits for further investments or to pay down partnership mortgages, having a corporate members allows them to do so without paying the higher rates of personal tax on those retained profits. Similarly, the individual members may wish to reduce their ‘taxable income’ for tax purposes.

Other advantages of an LLP

Individual landlords may not qualify as a business in their own rights for the purposes of claiming incorporation relief . However, as a result of the pooling their resources, by forming an LLP, their eligibility for incorporation reliefs eventually becomes unquestionable. Likewise, when a ‘whole business’ is transferred into a Limited Company by a partnership, there is relief available to mitigate the Stamp Duty Land Tax “SDLT” or Land and Buildings Transaction Tax “LBTT” where properties are located in Scotland .

As you might expect, HMRC has anti-avoidance provisions to ensure the tax system isn’t abused by landlords who might form LLP’s simply to avoid tax at the point of incorporation. Those provisions are known as “GAAR”(General Anti Abuse Rules). In Scotland, the word “Abuse” is replaced with Avoidance in GAAR. By way of example of the way GAAR affects SDLT relief in England, Section 75a of the Finance Act 2003 explains that claims for relief on Stamp Duty may be ignored if a partnership claims the relief within three years of formation.

Where ‘taxable rental profits’ and other taxable income from all sources combined exceeds an average of £50,000 per owner it is often the case that a Limited Company is a more tax advantageous structure than an LLP. However, an LLP is often used as a ‘stepping-stone’ strategy where a partnership doesn’t already exist. This is especially the case where mortgage debt is significantly less than the original acquisition costs of the property portfolio as a whole, because there is then a further opportunity to consider Capital Account Restructuring as part of the tax planning process. Furthermore, Limited Companies also provide additional Inheritance Tax “IHT” planning opportunities in the form of Freezer shares to cap the value of shares for the older generation and to accrue future growth in share value for the younger generation of the family.

Another benefit of the LLP structure is that it is a separate legal entity, much like a Limited company. Therefore, it cannot be argued that a Limited Liability Partnership is not a business, even if there is only one property.

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Limited Liability Partnership “LLP” LANDLORDS’ CASE STUDY

Bob and his brother Richard own six rental properties in a Limited Company, another six in joint ownership and three each in their sole names. Richard owns another three properties jointly with his two sons, two jointly with his wife and another jointly with his mother. Bob owns two further properties with each of his daughters, another two jointly with his father and four more jointly with his wife.

In total that’s 10 individuals across three generations of one family, plus a limited company, owning 34 properties between them.

As of April 2019, between the 10 individuals they can receive £500,000 of taxable income before they become higher rate tax-payers. However, the current basis of ownership doesn’t allow for profits to be allocated in that way.

The problem is that Bob and Richard have taxable income well into the higher rate tax bracket whilst the others have plenty of ‘headroom’ as basic rate tax-payers. This means that Bob and Richard are paying 40% tax on a proportion of their rental income and are also suffering the phased impact of finance cost relief for individual landlords.

The solution

All of the family members decide to pool their resources by forming a Limited Liability Partnership “LLP”.

Each of them starts with a positive capital account balance, which is the value of their net equity in their properties (i.e. value minus mortgage balance).

They then agree to “allocate” profits disproportionately to ownership. This doesn’t affect what each of them withdraw from the business, but it does affect their tax position to the extent that none of them will be pushed into the higher rate tax band, even after the restrictions on finance cost relief are fully phased in.

One of the most powerful tax planning opportunities associated with partnership is the ability for the partners to agree to allocate profits disproportionately to ownership, and to take drawings out of the business disproportionately to profit allocation.

Bob and Richard agree to allocate far less of the partnership profit to themselves than they had previously taken. However, they continued to withdraw the same amount as they had always done to this business. Over a period of time this results in the value of their capital accounts decreasing in value – which is good news for IHT purposes and its also good news for them because they pay less tax. They are now unaffected by Section 24.

To balance this, the youngest generation do exactly the opposite. Their profit allocation is significantly higher than they would have previously taken, but still within the basic rate tax band. Their drawings from the business were much lower though, save for the increased amount of tax they now pay on the higher amount of allocated profits. This results in the younger generations capital accounts growing in value by the amount of profit they are retaining in their capital accounts.

The family are all happy with this because:-

  • Between them they pay significantly less tax

  • None of them are any worse of in terms of actual spending power

  • The younger generation have larger income to show to mortgage lenders when buying their next home

  • The value of the estate is reducing for the elder generation, which is good for IHT purposes

  • The younger generation will pay less IHT when the elder generation pass away

  • All of the tax is paid by the business and debited from the value of each members capital account

  • The younger generation had always intended to retain profits anyway, because they want to grow the business

  • Any combination of up to four members can now purchase further properties and hold them ‘on-trust’ for the partnership

This structure works particularly well for families who own rental properties in a variety of combinations, and particularly when their incomes fall into different tax bands.

The costs of forming such partnerships are relatively low too. This is because LLP’s are tax transparent. This means that Members of the partnership can hold assets ‘on-trust’ for the partnership. This flexibility goes some way to explain why most Solicitors practices these days are LLP’s. Also, it isn’t possible for more than four partners to be registered legal owners or on a mortgage deed either.

So what about CGT, Stamp Duty and refinancing when the properties are transferred into the LLP?

This is another beautiful quirk of the LLP structure. Because they are tax transparent, and members can hold properties ‘on-trust’ for the LLP, there is no need to transfer the ownership. Therefore, there is no conveyancing, no need to refinance and no CGT or Stamp Duty to pay because the ownership of the assets never actually needs to be transferred.

The costs associated with taking proper legal advice and having all the correct documentation professionally drafted to set up up arrangements like this are much less than you might think too. Quotes we have obtained range from £4,995 to £9,995 + VAT, depending on the number of partners/members and properties involved.

A step by step guide of how to incorporate your properties into a limited company via a partnership Act 1890

The below step by step guide will help you understand the process of benefitting from the incorporation relief when moving buy to let properties into a limited company. The below complies with the requirement of the Partnership Act 1890.

1) Complete the Partnership

– Online registration if you have a government gateway login: SA400 and SA401’s and then send to HMRC. HMRC will then provide a Unique Tax reference code for the partnership.

– Forms if you do not have a government gateway login: SA400 and SA401’s and then send to HMRC. HMRC will then provide a Unique Tax reference code for the partnership.

2) Prepare a partnership agreement (we recommend utilising the support of a solicitor in drafting this important document). This document needs to outline the amount of capital contributions as well as the flexibility each year to allocate profits based on the efforts put into the partnership (as you see fit). You and the solicitor need to ensure that the partnership agreement and arrangement is watertight to ensure it does not fall into HMRC’s definition of “Sham partnership” (just to avoid tax.

3) Submit 3 years worth of self-assessments for the partnership. Please note that any property revenue losses upon incorporation (ie those you can use to offset in the year) will then be lost as they cannot be offset against partnership profits.

4) You will need to work with your mortgage broker/banks to arrange finance in the limited company to replace existing mortgages. This may take some time so it is best to start this process nine months in advance of the incorporation date

5) Once 3 years worth of partnership accounts has been produced it is now possible to incorporate the property business into a company. The share allocations will be based on the capital contributions from part 2 to ensure that there are no CGT/SDLT issues. The share values will be based on the net assets of the partnership.

6) You will need to work worth us/your solicitor to agree on what you do with the “Directors loans” and any Latent Gains for Capital Gains Tax purposes. This is based on the mortgages in place that are greater than the original acquisition costs of the property portfolio. This is otherwise known as a capital account.

Mortgage editor's comments

Partnership incorporation, in compliance with the Partnership Act 1890, is a great way for a buy-to-let property investor to transfer their portfolio into an SPV limited company. It’s becoming a hugely popular way of mitigating tax – especially for investors whose buy-to-let incomes have pushed them into the higher-rate tax payer band.

Incorporation is a lengthy process, which must be executed correctly in order to reap the rewards.

And once the process is complete, you’re free to enjoy the most tax efficient buy-to-let property ownership structure available in the UK today.

Get in touch with our team to start your partnership incorporation financial journey now.

How much does it cost to incorporate your buy to let properties into a limited company?

There are a number of costs that you need to consider when thinking about incorporating your buy to let properties into a limited company.

Many partnerships that have been through the incorporation process have paid between £8,000 and £25,000 in legal and finance fees.

Legal fees

There are solicitor conveyance costs that need to be paid. Solicitors will draw up partnership agreements and perform the conveyance of your properties from your personal name into a limited company.

Conveyance solicitors will also provide legal advice of h0w to go through the incorporation process.

Finally, conveyance solicitors will send the Stamp Duty Land Tax (SDLT1) forms to HMRC, which are used to show the tax paid.

Buy to let mortgage redemption penalties

Incorporating a property into a limited company also means paying off the buy to let mortgage in your own personal name. Paying off a buy to let mortgage early could result in a penalty. This financial penalty is often referred to as a redemption penalty. The reason why this penalty arises is because you paid off the buy to let mortgage early. The banks in question will lose on the mortgage interest costs that you signed up to on your mortgage terms and conditions.

Buy to let mortgage arrangement fees

Not only will you have to pay a buy to let mortgage redemption penalty but you may also have to pay a mortgage arrangement fees. This fee will be paid as your limited company will be getting a buy to let mortgage in place to buy the property.

Mortgage broker fees

The mortgage broker will also need to be paid. They will be working on your behalf to pay off the existing mortgages and put in new buy to let mortgages in the name of the limited company.

Of course tax

We have already talked at length about the various forms of tax that you may have to pay. We have also demonstrated many ways in which UKL landlords may mitigate the various forms of property tax when looking to incorporate their property portfolio into a limited company.

Is it really worth incorporating your buy to let portfolio into a limited company?

There are many advantages of incorporating a buy to let property portfolio into a limited company. However, as you can see from the above that there are a number of costs associated with this process.

You will need to weigh up the initial costs of incorporating your buy to let portfolio into a limited company and the tax benefits that you may benefit from in the future.

You will initially have the high costs of the incorporation process to gain from the tax savings benefits in the future.

This means that the process of moving residential properties into a limited company may not be cost effective in the early years.

What are the possible Capital Gains Tax changes in 2021?

In July 2021 Rishi Sunak the chancellor of the exchequer requested the Office of Tax Simplification (OTS) a review of the capital gains tax system. It is fair to say that the Capital Gains Tax review – first report: Simplifying by design proposes a number of changes to the current Capital Gains Tax system.

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