Incorporating a property business: when it works, and when it doesn’t
Few areas of private client tax generate as many enquiries at the moment as the incorporation of a residential property business, and few are as easy to get wrong. The restriction of finance cost relief for individual landlords, fully in force since April 2020, means that a higher or additional rate taxpayer can no longer deduct mortgage interest from rental profits in the way they once could, receiving instead only a basic rate tax reducer. Set that against several years of higher interest rates and it is not hard to see why so many landlords, and the accountants who act for them, have started to ask whether the portfolio would be better held through a company. The answer is often yes, but only once the entry costs and the ongoing position have been properly modelled, because incorporation done in haste can cost far more than it saves.
Why a company can help
A company is not caught by the finance cost restriction. It deducts its interest in full against rental profits and pays corporation tax on what remains, currently at 25% where profits exceed £250,000, with marginal relief between £50,000 and £250,000 and a small profits rate of 19% below that. For an owner taxed at 40% or 45% personally, the difference in the rate applied to retained profit can be substantial, and it is compounded where the intention is to reinvest rather than to draw the income out. That last point matters a great deal. Profit extracted from the company by dividend or salary carries a second layer of tax, so incorporation tends to suit the landlord who is building and retaining a portfolio far better than the one who needs every pound of rent to live on.
The two hurdles on the way in
The attraction of the destination should never be allowed to obscure the cost of getting there, and there are two hurdles in particular.
The first is capital gains tax. A transfer of properties to a company is a disposal at market value, because the parties are connected, so latent gains crystallise on the way in. Section 162 TCGA 1992 incorporation relief can defer that charge by rolling the gain into the base cost of the shares received, but it applies only where a genuine business, rather than a passive investment, is transferred as a going concern in exchange wholly or partly for shares. Whether a lettings activity amounts to a business for these purposes is a question of degree and activity, and the decision in Ramsay v HMRC remains the reference point. A modest buy-to-let held with little involvement will struggle; a substantial portfolio actively managed by its owners is on much firmer ground. The relief is given automatically where the conditions are met, so the planning lies in ensuring, and being able to evidence, that they are.
The second hurdle is stamp duty land tax, and it is the one that most often stops a transaction. The company’s acquisition of the properties is charged to SDLT on their market value, again because the parties are connected, and for residential dwellings that will include the additional dwellings surcharge. On a sizeable portfolio the figure can run well into six figures, which for many prospective clients is simply prohibitive. This is where the way the business has been run becomes decisive. Where the properties are genuinely held and operated in partnership, the partnership provisions in Schedule 15 FA 2003 can reduce the chargeable consideration substantially, and in the right case to nil, because the calculation reflects the partners’ existing connection with the company that acquires the business. That outcome is not a given. It depends on the detailed sum of the lower proportions calculation, it depends on the partnership being real rather than a device assembled shortly before incorporation, and it must survive the anti-avoidance rules, all of which HMRC scrutinise closely. It is precisely the sort of question where specialist input earns its keep, and where a partnership with genuine substance and a track record is worth a great deal more than one created the week before completion. The position in Wales and Scotland differs, with land transaction tax and land and buildings transaction tax each applying their own rules.
The wider picture
Two further points are worth flagging early. A company holding residential dwellings worth more than £500,000 falls within the annual tax on enveloped dwellings regime and must claim the relevant relief, typically for a property rental business, each year, so the compliance obligation does not end at incorporation. And while incorporation is often presented as an inheritance tax solution, a company holding investment property does not attract business property relief, so the shares remain fully chargeable. What incorporation does provide is a platform on which succession can be built, through growth or freezer shares that channel future value to the next generation, but that is a structuring exercise in its own right and not an automatic consequence of putting the portfolio into a company.
None of this is a reason to avoid incorporation. It remains one of the more powerful tools available to a property-owning client, and for a substantial, actively run portfolio held by higher rate owners who intend to retain and grow it, the case can be compelling. But the capital gains and stamp duty position on the way in, and the cost of extracting profit once inside, mean the numbers have to be worked through in full and in advance. If you have a client weighing this up, the earlier the conversation the better, and we would be glad to help.
The finance cost restriction: why a profitable let can still produce a tax bill
For an individual letting residential property, the way mortgage interest is relieved changed fundamentally over the second half of the last decade, and the effect is still catching people out. Under what practitioners still call the section 24 rules, phased in from April 2017 and fully in force since April 2020, a private landlord can no longer deduct the interest and other finance costs on a residential letting as an ordinary expense of the business. Instead, the profit is calculated as though the borrowing did not exist, and relief for the finance cost is then given separately, but only as a reduction of the tax bill at the basic rate of 20%.
For a basic rate taxpayer the arithmetic broadly comes out in the same place as before. For a higher or additional rate taxpayer it does not. Someone paying tax at 40% or 45% now obtains relief on their borrowing at only 20%, so the true cost of the debt has risen sharply, and after several years of higher interest rates that gap has become painful. Worse, because the rental profit is now stated before interest, it is a larger figure, and that larger figure can drag a landlord into a higher tax band, erode the personal allowance once income passes £100,000, or trigger the high income child benefit charge. In the most heavily borrowed cases it is entirely possible to hand over more in tax than the property has actually made, which is a difficult conversation to have with a client who thought they were running a modestly profitable portfolio.
It is worth being clear about who this does and does not affect. The restriction bites on individuals, and on partnerships and trusts, letting residential property. It does not apply to companies, which continue to deduct their finance costs in full, and it does not apply to genuinely commercial property. The old carve-out for furnished holiday lettings has now gone, because the furnished holiday letting regime was itself abolished from April 2025, so properties that once sat outside the restriction on that basis are now within it.
There is no single answer to the problem, and anyone offering one should be treated with caution. Incorporation is the response that attracts the most attention, because a company escapes the restriction entirely, but it carries its own capital gains and stamp duty costs on the way in and is only worthwhile in the right circumstances, as set out above. For some, reducing gearing or repaying debt is the more sensible course. For a married couple or civil partners, reviewing how the properties are owned between them, and how the income is split, can move profit onto the lower earner’s tax rate and soften the effect. And in every case the answer depends on the wider picture, on what the client needs from the portfolio, and on what they intend to do with it over the coming years.
What the restriction has really done is change the economics of buy-to-let, quietly and permanently, so that decisions which once made sense on the back of an envelope now need to be worked through properly. If you have a client whose rental tax bill has crept up in a way they cannot quite explain, it is usually the section 24 rules at work, and it is worth a proper look. We would be glad to help.
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