Property Investment LLPs
Sometimes it seems as though, the more you look at Limited Liability Partnerships, or LLPs, the more tax advantages come out of the woodwork. In this piece, we’re concentrating on LLPs set up not to carry on a trading business, but to hold a property portfolio.
At one time it was very popular for property holding companies to be set up: that is, limited companies incorporated with shares etc.
The practical advantages of holding property in an entity such as a company shouldn’t be underestimated. Where more than four people have an interest in a UK property, for example members of a family, or an investment syndicate, it’s not possible for all of them to be noted as owners on the deeds. Also, if you’ve got the situation where different people’s interests in the property portfolio may change as time goes on, it’s a hundred times easier to move shares between individuals in the overall property holding company, than to try to change the percentage shares between individuals on a whole host of properties.
A property holding company provides a professional and business-like structure through which the property is held, and also provides a fairly rigid and well understood legal structure, governed by a preset Memorandum & Articles of Association.
Despite all the advantages, property holding companies aren’t exactly flavour of the month any more, and the reason for this, as will perhaps become clearer in what follows, comes down to that nasty little three letter word: tax.
LLPs, on the other hand, are rapidly becoming much more popular as a vehicle for holding a property portfolio. Again, tax is at the heart of this, but before going into our “compare and contrast” exercise, as between the advantages of LLPs and limited companies, a word for the uninitiated, about what LLPs are.
LLPs are very much the “new kid of the block”. The legislation introducing them wasn’t effective until April 2001, so they are only ten years old, and the benefits of using them still aren’t widely understood. What they really are is not partnerships but corporate entities like companies, which share most features in common with companies (separate legal personality, limited liability protection, and so on) except for the fact that they are treated for tax, by a kind of legal fiction, as if they were partnerships.
In the case of an investment activity, their tax treatment is more akin, probably, to joint ownership, but with the important difference that you can have different proportions of income and capital entitlements, and entitlement to vote on the LLP’s affairs.
This really makes LLPs an extremely flexible way of holding property in which a number of different people have an interest, and with the increasing flexibility comes a lot of the tax advantages we will now come on to discuss.
It’s probably easiest to set out the way LLPs impact, in the context of a property portfolio, on the five principal taxes that afflict property investment: capital gains tax, national insurance, stamp duty land tax, income tax, and inheritance tax.
Of these, the first three are examples of how LLPs are better than limited companies as a vehicle for holding property. The last two are examples of how LLPs even improve on direct personal ownership, from the tax point of view, that is, as well as from the point of view of the practicalities we’ve mentioned above.
1. Capital Gains Tax
For CGT purposes, properties owned through an LLP are treated as effectively owned directly by the partners. This means that, unlike the situation with a limited company, personal tax reliefs and rates are available if the partners concerned are individuals themselves.
The standard rate of CGT for individuals on investment properties can now be taken for most purposes to be 28%, following 2010’s June Budget. With a company, however, the rate may be lower initially but is only one of two layers of tax that would be charged if you actually want to have personal benefit from the gains. Overall, in that situation, the company increases the rate of tax very considerably. So LLPs, with the ability to attribute gains to the individual members, definitely score on the overall tax rate on capital gains.
They also score on the availability of reliefs. A company basically has little or nothing it can do to mitigate tax on capital gains it makes. Individuals, including individuals holding through LLPs, in contrast, can get out of CGT by such things as the main residence election, personal trading losses elsewhere, and emigration from the UK.
All of these benefits, however, it should be pointed out, are equally available to property portfolios held in the direct name of the individuals. It’s just that the practical benefits, and the benefits of flexibility, that an LLP gives are not present in a direct personal ownership structure.
2. National Insurance
It may seem odd to talk about national insurance in the context of investment property portfolio, but there’s no doubt that it becomes relevant if you set up your portfolio through a limited company. The likelihood is that you may want to pay one or more of the individuals concerned, in return for looking after the portfolio. If he gets paid more than his percentage entitlement to the shares in the company, this effectively, in practical terms, has to be by way of paying him a salary or directors’ remuneration. This is where we suddenly find national insurance rearing its ugly head, even though the income out of which these wages are paid is investment income, which normally wouldn’t bear NI.
An investment property LLP, on the other hand, is at liberty to give one of its members a greater income profit share than his capital entitlement would naturally give him. For example, one of the family members, owning a family buy to let portfolio through an LLP, might be deputed by all the others to look after the portfolio full time. He may only have, say, a 5% interest in the properties, but you can give him a lot more of the income, under the LLP agreement, than 5%, in return for his full time work. In our view, this still comprises a share of investment income rather than earned income, and so shouldn’t attract any NI liability at all.
3. Stamp Duty Land Tax
Unless you go in for an aggressive SDLT saving scheme (and sometimes even then) you have to accept that an SDLT charge arises when you buy a UK based property.
However, what you might not have bargained for, is another SDLT charge springing up when you reorganise the portfolio by putting it into an investment holding company. Unfortunately, this rule is almost impossible to get around. Even if the company is owned by all the same people as previously owned the property, and even in the same proportions, a transfer of a UK property to a company will always trigger SDLT on the full market value of the property. (Come to that, CGT will also apply if it has gone up in value between acquisition and it being introduced into the company.)
LLPs are much more favourably treated where the members are all connected with each other, for example by being relations. In this instance, SDLT doesn’t arise, or doesn’t arise except to the extent that there are unconnected LLP members. So at worst you might only be paying SDLT on a proportion of the property, not on all of it.
4. Income Tax
Now we come on to what is arguably the most interesting aspect of holding property portfolios through an LLP: the ability to reduce the amount of tax paid on the rents.
In practice this can be done by introducing a limited company as a member (although watching out for the SDLT effects).
If a proportion of the rents is attributed to the company, in practice even if this is a high proportion, the company will be liable to corporation tax on the rents, which may well be at a much lower rate of tax than the income tax that the individuals would have paid. If the individuals are also the shareholders in the company, they are therefore achieving a real benefit.
And even if the rents are paid out to the individuals, not the company, this favourable tax situation can continue. Having introduced the properties into the LLP in the first place, the LLP therefore “owes” the individuals what can sometimes be a very large sum of money. This can be paid out to them, out of the rents, by way of capital repayment, no tax.
As with any tax planning structure, there are caveats and difficulties which, at least at present, are purely theoretical, however this isn’t meant to be a technical or theoretical treatise but a practical, action based article.
5. Inheritance Tax
This is another example of where an LLP structure can be better than direct personal ownership. What you do by putting property into an LLP is not, at least initially, to reduce your estate value. In place of your ownership of the properties you now have a paper interest in the LLP.
But this paper interest can be given away to others and, providing you survive seven years, the corresponding value will move out of your estate tax free.
The amount of capital you give away in this fashion is entirely up to you: it doesn’t need to be all. Providing you also reduce your entitlement to income out of the LLP correspondingly, this is effective for inheritance tax, we think, even if you are the original owner of the properties and you retain complete control over the way the portfolio is managed – just so long as you don’t give yourself any kind of “unfair” advantage as a result of that control.
In some ways, then, a family investment LLP can act as a trust, with the older and wiser heads looking after the wealth of the younger and more foolish (or at least more vulnerable). But unlike a trust, there’s no automatic lifetime charge to inheritance when you put the properties in, even if those properties are worth more than your inheritance tax nil rate band (currently just over £300,000).