THE PROPERTY COLUMN
Property-investment LLPs
Whether or not there are actually green shoots out there in the property market at the moment, a lot of people we are talking to are acting as if there were, and in a way that’s likely to be a self-fulfilling prophecy. At the end of the day, a property recession is less about figures and more about attitude: the attitude, particularly, of professional property investors and banks.
So this piece looks to offer an answer to the question, ‘How should I structure my investment property portfolio?’ That is, what holding vehicle should you use?
Of course, what follows has to be read with the caveat that real-life situations are all different, and one size does not fit all. But do consider the major potential benefits of a limited-liability partnership (LLP) as a vehicle for holding your portfolio.
LLPs
If you are an occasional reader of these words, you might not have come across LLPs, or know a lot about them. Regular readers will certainly have been exposed to this new business concept!
LLPs are a hybrid, you could say, of limited companies and partnerships. Like limited companies, they have their own separate existence as legal persons (which English partnerships don’t), but they are taxed like partnerships, that is profits made by the LLP are taxable directly on the partners, or ‘members’, and capital assets owned by the LLP are treated for tax (in particular capital gains tax) as if they were owned by the members.
A ‘typical’ structure
Let’s leap straight into a structure that may be highly tax advantageous, and explain how these advantages might come about.
Take an LLP whose members are individuals and members of one family, and a limited company that they own. This LLP owns a property portfolio. The interests of the members in the LLP, let’s say, are set out so as to allocate the bulk of the rental income from the portfolio to the limited company member, but capital gains on any disposal of properties are allocated to the individual members.
Now let’s compare this with two alternative structures, which are direct ownership by the individuals on one side and ownership by the limited company on the other.
Tax on rents
In the LLP structure, the rents will end up being allocated wholly or mostly to the company, and will normally pay no more than 21% corporation tax there. This seems better than the alternative of straightforward individual ownership of the properties, where at least some of the individuals may be liable to 40% or 50% tax on the rents.
On the other side, in the alternative that consists of a limited company owning the portfolio, the tax position is the same between this and the LLP: the income gets taxed at corporation tax rates.
Capital gains
When you turn to the taxation of capital gains, on selling one of the properties in the portfolio, the boot is on the other foot. Capital gains tax (CGT) for individuals is now at 18%, and there are various reliefs available too, such as ‘main residence’ relief (if the property is, or has at any time been, your main residence), and an exemption from CGT if the individual is non-UK-resident.
The company, on the other hand, pays full corporation tax at 21% to 28% (usually near the higher end of the scale) with no available reliefs on an investment property portfolio other than the relatively trivial ‘indexation allowance’.
Having paid this, say, 28% charge, the company has then got to pay out, eventually, the net of tax profits to its shareholders, which could give rise to another tax charge, probably in the range of 18% to 36%. Overall, then, you could sum up company gains tax as being typically in the 40% to 50% range in total, depending on all the circumstances.
Let’s look, then, and see how our three portfolio holding structures score.
The directly owned portfolio scores very well, since the individuals will be eligible for the 18% tax rate and the various individual CGT reliefs. The LLP is effectively the same, because gains can be attributed, in the LLP agreement, only to the individual members and not to the limited company. The limited-company ownership structure, on the other hand, seems an unmitigated disaster as far as capital gains are concerned, with the overall 40% to 50% typical rate applying.
Summary
Property-investment LLPs can also be used for inheritance-tax planning, as we’ve pointed out elsewhere. To concentrate on the taxes we have been discussing in this piece, which are income tax, CGT and corporation tax, you could sum up the situation by saying that the LLP enables you to pick and choose very efficiently what tax rate you will pay.
On the same portfolio, both income and capital gains are likely to arise. Because of the way our peculiar tax system is structured, income is usually taxed at a much lower rate on companies, and a much higher rate on individuals. Capital gains are the exact reverse, with individuals enjoying very low rates and companies paying through the nose.
So the LLP structure, if you get the documentation right, enables you to siphon off the income to the company and the gains to the individuals, so you get the lowest tax rate available in each case. The idea is simple, but the amounts of tax saved can be colossal.