"Repay your property investment loan through a trading company"

[Brendan Burgess]

Mark Doyle of Grant Thornton has an article in the current edition of Accountancy Ireland called "Topical Tax Tips for Practitioners"

To repay €1m of capital will require €2m of income before tax

Where the borrower is a shareholder or director of a privately held company it is worth considering transferring the asset and debt into the trading company.
It should then be possible to repay the debt at corporation tax rates of 12.5% rather than income tax rates of 50%.

The company cannot pay over the odds for the property transferred.

For simplicity, let's leave out the problem of negative equity and assume that I have a property in my name worth €1m and a mortgage of €1m on it. Let's assume that I own 100% of the company.

Mortgage|€1m
Interest rate|6%
Term left|15 years
annual interest|€60,000
Rental income|€60,000 (For simplicity)
total repayment|€100,000

There is a short term cash-flow advantage. For example, if the company is making €45,000 in profits, and I leave them in the company, it will leave with €40,000 net with which to meet the shortfall. If I keep it in my own name and pay myself €45,000 gross, I will only have €22,500 towards the capital repayment.

But the disadvantages seem huge to me
The stamp duty costs of selling the property to the company and buying it back again after 15 years
The legal costs of selling the property to the company and buying it back again after 15 years
Professional fees for tax advice
Revenue would presumably be highly suspicious of any such transaction and would want to verify that it was done at arms length valuations.
After a few years of capital repayments, the rental income will exceed the interest paid, and the rental profit will be subject to an effective rate of 40% tax within the company and further tax when it is paid out to the shareholder.
After 15 years, any capital gain on the sale of the property back to me will be taxed at 30%.
My shares in the company will have increased in value by the net amount, and this will be stuck in the company as cash or will be subject to income tax if it's paid out to me.
The company will have accumulated reserves and a significant property asset unrelated to the business. This is messy if you want to sell a shareholding in the company. The purchaser will not be just buying into the earnings power of the company, they will have to find more money to buy an unrelated asset.
If I want to give someone a profit share, I will have to exclude the rental profit.
If the company gets into financial difficulty in later years, the creditors will have a valuable asset to go after.
Probably more vulnerable to changes in the tax regime over the next 15 years.
Possible loss of a cheap tracker


So what are the advantages?
The immediate cash flow advantage and maintenance of your credit rating
The bank might be happier as you are more likely to be able to meet your repayments
Possibly avoidance of penalty interest rates from the bank
Able to set off the rental loss against trading profits (I presume that this is possible in the same year?)
Able to set off rental profits against trading losses

It would seem to me that other solutions should be explored first

• Sell the property to a third party
• Try to renegotiate the payment schedule with the lender

The article also says

The shareholder may consider taking an option to acquire the property back from the company at some stage in the future; in this way, it should be possible to ensure that future uplifts in property value accrue to the shareholder and not the company.

I can't see how this would work. If the company sells the property at less than market value, presumably the shortfall would be a BIK and subject to income tax. If I own the property directly, it will be subject to CGT.

 

[J.Ryan]

Quote:The shareholder may consider taking an option to acquire the property back from the company at some stage in the future; in this way, it should be possible to ensure that future uplifts in property value accrue to the shareholder and not the company.

I can't see how this would work. If the company sells the property at less than market value, presumably the shortfall would be a BIK and subject to income tax. If I own the property directly, it will be subject to CGT.

At the date that the shareholder sells the asset to the company, the company can sell an option to buy the asset back for €X, I'm assuming thats what he means

 

[Brendan Burgess]

Hi J

I understand what he actually means, but I can't understand how it works from a tax point of view. It would require very expensive tax advice to set it up, unless it's something which is done regularly.

 

[oldnick]

I'm not too good at this but as I'm in a vaguely similar position to the above example so I'm interested, but rather ignorant about tax rates....

- I thought corporation tax was 25% for rental income.

- Offsetting rental proifts against other trading profits is not, I had believed, as simple as that. I thought the off-setting of one type of income profit against another type of income loss (i.e. at different tax bands) was somewhat tricky.

- Also, if one has a property and transfers it to a company I assume there would be CGT to pay -assuming of course there's been any increase in value since the individual bought it ,somewhat unlikely nowadays.

- I'm unsure of the new Budget rule that allows one to buy now and any gain in value in first seven years is disregarded for CGT purposes if owned for over seven years.
This wouldn't be the same for company shares would it?
Mr X buys a building for a million and its worth 1.5m in seven years - no CGT.
Mr X's company owns same building but it's the share value that has increases by 500k in seven years - there are tax penalties.
(ok, maybe there'll be no increase in property prices ,but am I theoretically right?)

Actually, I must confess I don't understand how the article shows a boxed example of figures and then talks about a 45.000 profit. I'm too old to understand these things so I'll follow guru Brendan's advice and not form a company.

 

[Brendan Burgess]

- Also, if one has a property and transfers it to a company I assume there would be CGT to pay -assuming of course there's been any increase in value since the individual bought it ,somewhat unlikely nowadays.

I think that this plan is aimed at people with large mortgages. So it probably relates to people who have bougth within the past 10 years. So it's likely that they would not have capital gains. However, you have a valid point, and transferring the property may realise a capital gain. .

 

[Brendan Burgess]

- I thought corporation tax was 25% for rental income.

Thanks for correcting the guru. I have revised one of the disadvantages as follows:

After a few years of capital repayments, the rental income will exceed the interest paid, and the rental profit will be subject to an effective rate of 40% tax within the company and further tax when it is paid out to the shareholder.

I will go back to basics on this to clarify my understanding of how rental profits are taxed in a small company.

The Corporation Tax rate is 25%
A surcharge of 20% is payable on the undistributed rental income of a close company.

rental profit|€100
Corporation Tax|€25
Undistributed rental income|€75
Surcharge at 20%|€15
Total tax|€40

So the rental profits will be taxed at 40% in the company, compared to 50% in the hands of the individual. However, when the €60 retained profits are eventually paid out to the director, they will be taxed again.

Back to the original point of this article. Does it make sense for a company with trading profits to use these retained profits to repay the loan?

These profits will be taxed at 12.5%, so the short term cash flow will be higher.

But when the capital is reduced the rental profits will be taxed at 40%.

Brendan

 

[Gekko]

The potential double hit of CGT on the sale of the property is a big issue.

PropertyCo is hit for CGT on disposal of the company and then the investor is hit for CGT on liquidation of the company.

 

[oldnick]

Seems to me , based on my own poor knowledge plus comments from others , that the magazine article needs to outline all the ramifications of such a move. Or ,in basic terms , is a load of xxxx.

 

[mandelbrot]

Seems to me , based on my own poor knowledge plus comments from others , that the magazine article needs to outline all the ramifications of such a move. Or ,in basic terms , is a load of xxxx.

Ah but it doesn't, it's an article in Accountancy Ireland (the magazine for Chartered Accountants, not laypersons) - it merely says that "Where the borrower is a shareholder or director of a privately held company it is worth considering transferring the asset and debt into the trading company."

Now I haven't read the article, and this thread has highlighted some of the potential pitfalls, but the point is that the author of the article is highlighting something that could be of benefit to some people, certainly not a one size fits all approach.

TBH, such articles could be cynically viewed as a pseudo-advert - if you want to find out all the ramifications, and whether or not it's an option for you, you'll have to pay the experts who've run the numbers on it...!

 

[Joe_90]

Putting property into a company has always been avoided for the reasons outlined above. But with pressure on rents withdrawal/restrictions of capital allowances all avenues have to be considered.
I have considered where a director/shareholder is letting the property to the company and the co is making a profit moving the property into the company so that a the end of the day in is a business asset not an investment.
Don't think its appropriate for investment property in general.