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Incorporation of property assets
There is no doubt that the personal taxation landscape has changed significantly in Ireland over the last number of years. The introduction of the USC and increase in PRSI has seen the marginal rate of tax increase to 55%. In addition, the restriction, and in some cases total abolition, of a number of reliefs and allowances has ensured that individuals’ effective income tax rates are increasing. This trend has led individuals to consider their overall tax position and one aspect that is receiving increased focus is property holding structures; both for achieving lower effective tax rates on income generating assets and from an estate planning aspect.
In the past, it was generally considered that holding assets through a corporate vehicle was not advantageous, primarily due to the double exposure to capital gains tax (CGT) on the sale of the property. However, in the current taxation climate, and depending on an individual’s personal circumstances, holding property through a corporate vehicle is certainly worth considering. As with all restructuring proposals, there are both tax and non-tax issues to be considered.
Tax costs on incorporation
The main potential tax cost on the transfer of a property to a company is CGT. This is calculated based on the market value of the property at the date of transfer. However, given the decline in property values in recent years, it may well be that an overall loss is incurred on the transfer of the property, and hence no CGT is due. Individuals should be mindful that this loss is generally restricted so that it may not be offset against other capital gains tax the individual may have. It is possible to structure the transfer to ensure that this loss can be used against other gains, and is certainly worth considering if the loss claim is required.The other tax cost on transfer that obviously needs to be considered is stamp duty at a rate of up to 2%.
On-going tax costs and other considerations
One of the key advantages of holding a property through a corporate vehicle is the ability to achieve a lower overall effective tax rate on any rental income being generated from the property.
As mentioned above, the marginal rate of tax (which includes income tax, PRSI and USC) on rental income on property held personally can be up to 55%. However, the rate of tax on such income within a company is 25%. One aspect that would need to be considered is the close company surcharge on such income. In broad terms, this is an additional surcharge on investment income generated in companies which are controlled by five or fewer individuals. The effect of the surcharge is to bring the overall effective tax rate on such income to c. 40%, a rate which is still lower than the marginal income tax rate of 55%. In some circumstances however it may be possible to manage the close company surcharge, thereby achieving a tax rate of 25% on this income.
Another alternative worth considering, particularly for individuals with a sizeable rental portfolio, is the incorporation of a property management company which would charge a management fee to the property holding company. The management company would be a trading entity, and hence any income earned is taxable at 12.5%, whilst being tax deductible in the property holding company at 25%. Hence, an overall saving of 12.5% on such income in achieved. It also assists in relieving the impact of the close company surcharge.
Of obvious concern to an individual will be the reduced level of available income in his/her hands, given that the income now accrues to the company. It is necessary to enable the individual to access any funds within the company as tax efficiently as possible. Generally the property will be transferred to the company for an amount owing (i.e. as a director’s loan) thereby enabling him/her to draw down the after-tax income within the company tax free up to the value of the property. Once this has been exceeded, any additional income will be drawn down in the normal manner i.e. by salary or dividend, both of which will be subject to income tax, PRSI and USC in the individual’s hands.
Obviously the use of a company gives rise to other considerations such as the need for annual financial statements and a corporation tax return to be prepared, along with the filing requirements with the Companies Registration Office (CRO) and governance issues such as the need to hold AGMs etc.
Improved debt repayment / debt refinancing
An added benefit of holding a property through a corporate vehicle is given the lower rate of tax on income; the amount of after-tax income to service debt is increased. In addition, an individual may have a number of personal loans, some of which are not tax efficient. By transferring the property to the company, which in turn would borrow to fund the acquisition, hence allowing the individual to pay off his/her personal debt, non-tax efficient borrowings are converted into tax deductible borrowings within the company. Obviously such restructuring would be subject to bank considerations such as loan to value ratios, security considerations and evidence of free cashflow availability for debt repayment within the company.
Tax considerations on sale
It is not always clear at the outset what an individual’s intention with regard to the property may be. They may wish to hold the property in the long term either for future sale, or intend ultimately passing the property to their children. Alternatively, they may wish to sell the property in the short to medium term.
On the sale of the property, the company will be liable to CGT on any uplift in the property from the market value at the date of transfer to the date of sale. It should be borne in mind that a company can avail of the recently introduced relief from CGT which in broad terms would apply to properties transferred to a company between 7 December 2011 and 31 December 2013, and is held for a period of more than 7 years. The relief applies by way of a “tapering relief” by relieving any gain on the disposal of land or buildings by the same proportion that the period of 7 years bears to the period of ownership. For example, if a gain of €500,000 is made on a property owned for 9 years, the relief is 7/9th of the gain, leaving a chargeable gain of 2/9th i.e. €111,111.
The tax costs on extraction of the after tax proceeds from the company must obviously then be considered. It may be possible to structure the sale as a sale of the shares in the company, rather than the underlying property, thus avoiding the potential double CGT exposure, but this will depend on the combined preferences of both the vendor and the purchaser and may be influenced by both tax and indeed non-tax issues. It should be borne in mind that the relief from CGT discussed above would not apply to the sale of shares in the company.
Estate planning opportunities
Certainly for those individuals who may wish to pass the property to the next generation, it is worth planning for this at the outset, as holding a property through a company can work efficiently from an estate planning perspective.
Many parents wish to retain control over the company and the rights to any income flow from the company during their lifetime, but ultimately pass value in a tax efficient way to their children on their death. One such option would be to allow the children to purchase the future interest in the company shares at the outset (i.e. they will only become entitled to the shares on the death of their parents). Depending on the age of the parents, the market value of this future interest can be significantly less than the market value of the shares. Ultimately this structure allows the parents to achieve their objectives of retaining control and entitlement to the income flow, but allows the shares to pass to the children without a tax cost on the death of the parents.
Obviously the overall financial position and intentions of the individual must be considered before any incorporation of property proceeds, in order to assess the relative tax advantages. However in particular for individuals with non-tax deductible personal loans or those considering estate planning, this strategy certainly merits further exploration.