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Amongst a certain generation, there is a questionable belief that tangible assets are more profitable than a portfolio of investments. For hundreds of thousands of people in their 50s and 60s, ‘bricks and mortar’ have been seen as a sure-fire way to grow your wealth. You can see a house and you can touch a house, so surely property is a far more secure investment than ever-fluctuating stocks and shares, ebbing and flowing in the ether?
Well, no. For a start, ‘bricks and mortar’ are illiquid: they can take months, if not years, to sell, and, bar equity release, you generally have to sell them in their entirety. They also cost you to maintain: if your roof collapses the repair cost comes straight out of your pocket; if your tenants’ boiler breaks, guess who needs to cough up?
But these two factors alone are not why people are suddenly clambering to sell off their properties. Currently, one in five landlords and ladies are desperate to dispose of their portfolios, so why this sudden trend?
The truth is that buy-to-let investors have never had it so hard. The housing market is currently weak, and is set to further deteriorate, tough new legislation and higher taxes are making it harder to purchase a property for letting purposes, and lenders are consistently tightening their affordability checks. The main hurdle, as I will explain shortly, us the removal of Interest Rate Relief, meaning that mortgage interest will no longer be tax deductible. Retirement is also a huge factor, as many Buy-to-Let owners do not want the hassle of property investment, when they could receive the same returns from an easier to manage investment portfolio.
One of our recent clients, for the purpose of this piece is called Pete, came us to us with a real dilemma. For almost 30 years, Pete has been investing into a range of residential flats and houses, which now number nearly 40. Managing such a large portfolio of properties is Pete’s fulltime job; however, despite his rental income totalling nearly £19,500 each month, he takes a fairly modest salary of just £45,000 per year, as his outstanding mortgage debt currently stands at £1.5m.
Now that Pete is 55, he had started to consider his retirement. With all of his money tied up in illiquid property, he wanted to know how to sell his portfolio so that he could release some cash for his future. Of course, Pete had numerous obstacles to overcome to achieve his dream.
Over the coming years mortgage interest will no longer be tax-deductible, so many landlords with debt are going to have to pay more Income Tax. In retirement, increased outgoings are the last thing any of us want, so one option is to reduce the mortgage liability through the sale of property.
The general rule of thumb is that smaller properties offer a higher yield, so it is prudent for Pete to sell his most valuable, generally larger, properties first. By eradicating the outstanding debt, the rental income Pete makes could help to fund his future years and minimise the potential Income Tax he may face.
Another alternative would be for Pete to consider a company structure. By creating a company to ‘house’ the properties, Pete would incur a tax charge on the gain he has made on his properties, but he could qualify for ‘hold over relief’ if he could demonstrate that he was running his portfolio as a business; however, this is a very grey area.
Once in the company, the tax situation could slightly improve, as the net rental income and capital gains on future sales of the properties would be taxable at the lower rate of 19%. The downside is that when money is taken out of the company, Pete would be taxed as his marginal rate (currently 40%), so he would effectively be taxed twice. He would also be subject to higher rates of Stamp Duty if he transfers his properties to a company. He would also face paying Stamp Duty on his own properties, if he transferred them, meaning that placing the properties into a company could be a very unattractive option.
The second problem that Pete faces is sadly the glaringly obvious: property is illiquid. Whilst I do agree that property can form an important part of a diverse investment strategy, ‘housing’ all of your investments in property is rarely a prudent move. As I’ve already touched upon, houses cost money to maintain, but the real issue comes when you want to sell them. There are various taxes and levies to pay, which can significantly erode your wealth.
Obviously for Pete, this information comes a little too late; he has, after all, spent 40 years investing into property. However, that doesn’t mean that he can’t start to invest in other vehicles.
The strategy I suggested to Pete was that he set up some tax-efficient investments, namely an ISA and a Pension. ISAs allow you to grow your money virtually tax free and pensions allow you to defer your Income Tax to a time when you are likely to be subject to a lower rate. These wrappers often allow you to also invest in a diverse mix of funds, and elect the level of risk you want to take, so they can be tailored to your needs and goals.
By diverting some of his income into ISAs and Pensions, Pete can build up a ‘back-up’ strategy, which he can draw upon in his retirement and enable him to meet any unexpected costs or losses that his properties may cause.
If Pete fully utilised his ISA and Pension allowances, he could also look at some more sophisticated investment wrappers, namely EIS and SEIS, which could defer, and in some cases eliminate, some of the Capital Gains Tax upon sale of the properties.
The third tax hurdle that Pete may need to overcome is Inheritance Tax. For years, accountants have warned us that buy-to-let investors are amassing tax problems in the form of either Capital Gains Tax (if they sell while still alive) or Inheritance Tax (if they leave the properties in their estate).
For unmarried Pete, upon his death is estate will be taxed at 40%, as his assets far exceed the £325,00 single person threshold; if he were married, the joint allowance would currently allow for assets under the £650,00 mark to escape taxation. However, the newly introduced Residential Nil Rate Band means that further money from property could be added to this allowance, which increases each year with CPI, which may allow further IHT to be mitigated upon death.
Of course, recommending that Pete get married is not an option, so instead I recommended two strategies. The first was to make gifts during his lifetime, which would reduce his estate, ergo reduce the amount of Inheritance Tax payable upon his death. Pete can give away as much money as he chooses to, however this could have a detrimental effect on his own wealth, if he needed those funds at a later date. The monies would also end up in the estates of his beneficiaries, who in turn could lose Pete’s gift to IHT, divorce or other third parties. By simply gifting, Pete would lose control over what happens to his money if it’s gifted, and it could end up in the hands of people who he doesn’t want to receive it.
Gifting is all well and good, but for an unmarried person without children, it might not be the most suitable solution. Instead, I felt that Trusts might be a more suitable solution. When you put money or property in a Trust, provided certain conditions are satisfied, you don’t own it anymore. This means it might not count towards Pete’s Inheritance Tax bill when he dies. He would also be able to leave his assets, up to £325,000 free of Inheritance Tax, to his nominated Beneficiaries (for example nieces and nephews) to help them get onto the property ladder or realise some cash in later life when they may need it.
The fourth problem for Pete, and anyone else in a similar situation, is having to slowly sell off his portfolio. This will lessen the burden of Capital Gains Tax, but realistically this is a very slow strategy that could take him as long to accomplish as he has been accumulating his property portfolio. As Pete’s portfolio is solely comprised of residential property, he could stand to lose 28% in Capital Gains Tax per sale.
One way of navigating this problem is to make careful use of the ‘Deferral Relief’ available through a qualifying EIS Scheme. This is a very sophisticated strategy, that won’t be appropriate for everyone, but it basically means that the any gain that comes about from the sale of assets, in Pete’s case properties, can be invested into an EIS Scheme to defer Capital Gains Tax. There are strict rules and timescales in place, however, so this strategy can be highly complex and often comes with a high degree of risk.
In Pete’s case, if the total gain on a property was £100,000, he would be liable to pay £16,700 in Capital Gains Tax (28% of the gain minus his £11,300 allowance). However, if he reinvested the gain into an EIS, the Deferral Relief available would mean that he wouldn’t have to pay the £16,700 CGT to HMRC right away. Instead, he could actually claim 30% Income Tax relief on the investment, which means his tax bill will effectively be reduced to £11,690.
If Pete then went on to make a gain on the EIS investment and chose to sell it, he would be entitled to Capital Gains Relief, so no CGT will be payable at all on the gain from his EIS investment. However, the previous CGT on the property gain is once again applicable and would need to be paid to HMRC. Of course, he could choose to re-invest the gain in another EIS investment – a process that can be repeated over and over again, and he will have future years’ allowances to use.
For Pete, the growth he received on the EIS investment more than covered the CGT bill, so he effectively had some additional money to pay his tax bill and didn’t need to eat into the sum he needed to enjoy his retirement. The EIS also provides 30% Income Tax Relief, so the end sum was further increased.
Selling a property portfolio will cost you money somewhere down the line- predominantly through taxation, which is sadly inescapable for us all. If you are in Pete’s situation, we would recommend that you consult a financial expert now, to prevent you from over paying tax and potentially negatively impacting your future.
An accountant, solicitor and financial planner can work collaboratively to assess your situation, minimise your tax and look at solutions such as Trusts and property companies to help reduce the burden of selling off your assets.
At Efficient Portfolio we have a ‘Trusted Team’, which brings together all of these professional in one easy solution. If you would like to talk to us about selling your property portfolio, and gain access to our trusted professional contacts, please call 0517 898060 or email email@example.com.
The first step in achieving your goals is to discuss your current concerns with one of our qualified Financial Planners.