Incorporation Relief for UK Property Landlords

Incorporation relief is a valuable tax tool for UK landlords transferring property from sole trader or partnership to company. It allows landlords to defer CGT, preserve cash flow, reduce tax liability, and improve long-term financial planning.

In this guide, we'll explain how incorporation relief works, who can benefit, and what property landlords need to consider. 

Table of Contents

• What is Incorporation Relief?  

• Key Points About Incorporation Relief:  

• How Does Incorporation Relief Work?  

• Example: Incorporating a Property Business  

• Incorporation of the Property Business  

• Benefits of Incorporation Relief  

• Potential Pitfalls to Consider  

• Conclusion  

What is Incorporation Relief? 

Incorporation relief allows business owners to defer capital gains tax (CGT) when they transfer assets such as goodwill, property, or equipment from a sole trader or partnership business to a newly incorporated limited company. The key benefit of incorporation relief is that it defers CGT until you eventually sell the shares in the company, rather than paying tax on the transfer of assets to the company.  

Incorporation relief is particularly useful when transferring a business that has appreciated in value, as it enables business owners to avoid paying CGT on the gain at the time of incorporation. Instead, you "roll over" the CGT liability into the value of the shares in the new company, deferring the tax until you sell the shares at a future date. 

Key Points About Incorporation Relief: 

1. Deferral of CGT: The tax on capital gains is deferred until the shares in the company are sold, allowing for a more favourable tax treatment. It is NOT an exemption.  

2. Eligible Assets: Business assets such as goodwill, property, or intellectual property can be transferred to the company.  

3. No Immediate CGT Burden: Business owners do not have to pay CGT when transferring the business into the company, which helps maintain cash flow and enables reinvestment into the business.  
   

How Does Incorporation Relief Work? 

Let’s break down how incorporation relief works through a practical example, particularly in a scenario where someone owns multiple properties and decides to incorporate their property business.  

Example: Incorporating a Property Business  

Meet Timothy, a Property Investor

Timothy is a sole trader who owns over 15 rental properties. Over the years, his properties have appreciated in value, and he now owns a portfolio worth £5 million. Timothy is considering incorporating his property business into a limited company, but he is concerned about the potential capital gains tax he would need to pay if he sells the properties directly or transfers them to the company.  

You should also consider Stamp Duty Land Tax (SDLT), which we'll explore in more detail in a future blog post.

Without incorporation relief, Timothy would have to pay CGT on the gains he has realised from the properties. Let’s say he originally purchased the properties for £3,000,000, and their current market value is £5 million. This would result in a £2,000,000 gain.  

Capital gains tax would be in the region of say, 24% of £2m = £500,000.  

Incorporation of the Property Business 

Timothy decides to incorporate his business. Following thorough due diligence and detailed tax analysis, we form a new limited company and transfer his properties into the company in exchange for shares in the newly incorporated company. The market value of the properties (£5 million) becomes the value of the shares he receives in the company.  

Under incorporation relief, Timothy does not pay CGT on the £2,000,000 gain when he transfers the properties to the company. Instead, he defers the CGT liability by rolling it into the shares he receives in the company. 

Timothy "rolls over" and defers the capital gain of £2,000,000, meaning he doesn't pay CGT at incorporation. Instead, he'll pay tax on this gain when he eventually sells his shares in the company. 

This shouldn't cause concern, as we always advise clients to view these transactions as long-term strategies. 

Benefits of Incorporation Relief 

1. Deferring Capital Gains Tax: By using incorporation relief, business owners can defer CGT indefinitely, allowing them to keep more of the value of their business working for them in the meantime.  

2. Business Asset Disposal Relief: If the business qualifies for Business Asset Disposal Relief, the sale of shares in the company can be taxed at a reduced rate of 10% on the first £1 million of gains and 20% on any further gains.  

3. Preserving Business Value: Deferring CGT allows for the preservation of business capital, which can be reinvested to grow the business further.  

4. No Immediate Cash Flow Impact: As there is no immediate CGT liability, incorporating allows the business owner to avoid any cash flow strain caused by tax payments, particularly important for capital-intensive businesses such as property investment.  

5. Uplift in base cost: The underlying properties being transferred into the company achieve an uplift in its base cost to market value. This is a MAJOR advantage as years and years of capital gains can be wiped out. If sold the next day following incorporation, no capital gains tax will be payable.  
   

Potential Pitfalls to Consider 

While incorporation relief offers many tax advantages, there are a few potential pitfalls to consider:  

1. Not all businesses are eligible: Incorporation relief is only available for businesses that are actively trading. Property businesses that are purely for investment might not qualify for the relief unless they meet specific conditions. To qualify, it must be demonstrated that a business is in active operation.  

2. Unless the business operates as a partnership, Stamp Duty Land Tax (SDLT) will also need to be paid. For a business to be recognised as a partnership, it must be shown that the partners are engaged in sufficient activities related to the operation of the business.  

3. Future Tax Liability: Although incorporation relief defers CGT, it doesn’t eliminate the tax liability entirely. Business owners will eventually have to pay CGT when they sell their shares in the company.  

4. Ongoing Costs: Running a limited company involves additional administrative costs, including accounting fees, company formation fees, and annual filing requirements.  
   

Conclusion 

Incorporation relief is a powerful tool for UK business owners, allowing them to defer capital gains tax and take advantage of lower tax rates through Business Asset Disposal Relief. For property investors like Timothy, incorporating a property business can help minimise tax liabilities, preserve capital, and enable reinvestment in the business.  

However, it's important to consider whether your business qualifies for incorporation relief and understand the potential long-term tax implications. We highly recommend consulting a tax professional or accountant to help you maximise this valuable tax relief and make the best decision for your financial future. 

Property portfolio incorporation projects are always on the go here at ASWATAX. Our experienced and knowledgeable team will help you incorporate smoothly, ensuring no issues arise in the future. 

Meet Omar Omar is a Chartered Tax Advisor (a.k.a an expert on tax issues) and founder of ASWATAX. He regularly shares his knowledge and best advice here in his blog and on other channels such as LinkedIn. Book a call today to learn more about what Omar and ASWATAX can do for you.

*Disclaimer: ASWATAX is a firm of Chartered Tax Advisors, and we strive to provide accurate, up-to-date tax insights. Tax laws may change, so this content is for general guidance only and not a substitute for professional advice. Seek independent tax and legal counsel before making decisions. ASWATAX is not liable for any loss from reliance on this information. Use at your own risk.