If you own a mortgaged buy-to-let residential property, you are facing a “seismic change to your financial position” according to Henry Emson, business development manager at MMC Ventures.
Former Bank of England economist, David Miles, referred to the Government’s adjustment as “terrible”.
So what is this big change?
Since 6 April, interest payments are gradually ceasing to be an allowable deduction against rental income, meaning that historically profitable portfolios will turn into cash-negative assets.
However, if you decide to sell, you will have to pay between 18% and 28% Capital Gains Tax (CGT), depending on the rate of income tax you pay.
You will also need to find a new way to generate wealth – which isn’t easy, especially when interest rates are so low.
But there is no need to panic.
Rather than keeping the property because you don’t like the idea of paying CGT, there is another answer.
Sell it and invest the capital gain element in an Enterprise Investment Scheme (EIS).
EIS is a tool that will soften the blow. With careful planning, you can pay a lower CGT bill or even defer it altogether.
What is EIS
EIS funds invest in qualifying companies with significant growth potential. Apart from AIM companies, they have to be an early stage and unlisted, making this an ‘illiquid and high risk asset class’.
The Government created EIS investment reliefs to encourage innovation in the UK and create jobs in the private sector.
If you sell your buy-to-let property and invest your capital gain of £100,000 in an EIS, you’d achieve a net exit of £231,450 after seven years as shown in this illustration.
This shows a portfolio performance of 2 x multiple return, including settlement of the deferred CGT. It does not include the future benefit of 40% IHT exemption.
The combination of income tax relief and CGT deferral immediately provides a 58% tax advantage over, say, investing in FTSE 100 stocks.
Benefits of EIS
- Deferred CGT so your net worth is not diminished
- Income tax relief to bring down the net cost of investment
- Share loss relief to reduce your exposure to company failures
Capital gains on the disposal of EIS investments are free of tax. However, careful planning is needed to deal with the original capital gain that was deferred.
After you’ve owned your EIS shares for two years, they are exempt from inheritance tax.
In summary, EIS offers higher risk for higher rewards, with a downside buffer provided by HMRC and an added incentive for coming out of buy-to-let property.
What this means to you
EIS is not an equally weighted alternative asset class to property, but you are unlikely to find a more interactive investment for the capital gain when transitioning out of a buy-to-let portfolio.
Disclaimer: Investing in early-stage businesses involves risks, including illiquidity, lack of dividends, loss of investment and dilution, and it should be done only as part of a diversified portfolio. Tax relief depends on an individual’s circumstances and may change in the future. In addition, the availability of tax relief depends on the company invested in maintaining its qualifying status.
If you’d like any further information, please let us know. We’ll be happy to help.