The New Kid On The Block: Property Investment LLPs

Alan Pink considers the potential advantages of property investment limited liability partnerships, as opposed to other ways of holding property portfolios.

The myth is still surprisingly widespread that limited liability partnerships (LLPs) are only for accountants and solicitors. Certainly, the original pressure on the government to import an equivalent to the US LLC structure into UK law came from accountants. But LLPs have actually got a much wider potential scope than merely acting as vehicles for professional practices. Indeed, the legislation specifically envisages that people will set up LLPs to hold investment portfolios, which of course includes property investment. 

Like the US LLC on which it was modelled, the UK incorporated LLP is a kind of hybrid, sharing most of its practical, commercial, and legal features with limited companies; but being treated for tax purposes, by a kind of legal fiction, as if they were partnerships conducted by the LLP members. 

There comes a time in the life of every family property investment portfolio where the older generation decides that it’s time to do things on a more business-like basis. As anyone who has ever bought a property for letting will know, property ownership isn’t simply a question of sitting back and waiting for the rent cheques to come in – far from it. It very soon gets to be a full-time job looking after an assembly of buy-to-let properties. 

This might account partly for the popularity, a while ago, of setting up family investment companies. The company ownership gives a formal and ‘professional’ structure to the family business of owning and managing investment properties. 

Now that there is a ‘new’ kind of corporate entity available (LLPs were first formed in 2001), they are certainly worth a look to see whether they are a sensible alternative to limited companies as a way of providing this structured approach to property holding.

Having spent roughly half my career advising clients on LLP management and tax treatment, I have come to the conclusion that flexibility is the key word as far as LLPs are concerned. This is the case from all kinds of points of view, but one of these is the way income from the LLP’s assets is shared out amongst the members. 

An LLP agreement can be as narrowly prescriptive, or as flexible, as you choose; there is no pre-existing template with LLP agreements as there is with a company’s Memorandum and Articles of Association. So, there’s nothing stopping you, if you choose, building in very considerable flexibility from year to year as to how the LLP’s income is allocated between the members. 

The example below illustrates how useful this can be for tax planning purposes.

Mr and Mrs Green have one son, Peter, who is married with two children, Theresa and Patricia. Theresa and Patricia are still minors, being aged 14 and 16 respectively. Mr and Mrs Green set up a property investment LLP and transfer their reasonably substantial portfolio into it. The members are Mr and Mrs Green, Peter, Theresa, and Patricia.

In the year following the set-up of the LLP, the elder granddaughter leaves school (she was never an academic type) but the younger, Theresa, moves to a very expensive school, whose fees are £15,000 per term. Whilst Peter is earning a good salary, he still needs his parents’ help and, therefore, Mr and Mrs Green (who control the allocation of income from year to year in the LLP) decide to allocate a term’s worth of the rental profits directly to Theresa, so that the school fee bill for one term can be met. 

This is flexible because it enables Theresa’s personal allowance to be utilised, meaning that the income which would, in Mr and Mrs Green’s hands, have borne tax at 40% (or even 45%) bears a very low effective overall tax rate.

Note that the above would not have worked if the portfolio had been put into the LLP by Peter, the minor child’s father, because of the ‘settlements on minors’ anti-avoidance rules, which would have attributed the income to him.

Note another feature of the family property investment LLP in the above example, which is that the LLP agreement gives Mr and Mrs Green, the older generation, complete control over the allocation of income. There’s no reason, indeed, why this complete control shouldn’t extend to all aspects of the management of the LLP, including the question of whether properties are bought and sold, and whether any money is actually drawn out of the LLP and paid to members.

It’s true that this control aspect can be managed similarly in a limited company environment; but even here the key word is flexibility. An LLP agreement can be changed comparatively easily; compared, that is, with the greater formality required in changing a company’s governance structure by way of changing share rights, etc., under the Memorandum and Articles of Association. The control exercised by those in charge of an LLP can even encompass the admission and removal of members. 

So far, readers might be forgiven for feeling a certain confusion as to whether an LLP is better than a limited company as the vehicle for holding a property investment portfolio, because many of the advantages I have mentioned of an LLP would seem to apply, translated into different terms, to the company format. So, let’s consider specific differences between an LLP and a company as a property holding vehicle.

Firstly, although flexibility as to the allocation of income is possible within a company structure, by having different classes of shares it’s certainly a lot harder to admit new members and to exercise the flexibility in practice. On the subject of income, companies even now increase the overall income tax burden as a result of Mr Osborne’s ‘dividend tax’, which, very broadly, can add an extra 7.5% income tax burden as compared with simply receiving the rental income direct. But we need to go a stage further back in the logic to compare the two different corporate property holding structures properly. 

As many people considering companies as a way of getting around the dreaded ‘Clause 24’ disallowance of loan interest will have discovered, there are particular issues with the possible liability to capital gains tax (CGT) and stamp duty land tax (SDLT) (in England and Northern Ireland) when you incorporate a property portfolio into a limited company. In short, there can be crippling doubt, particularly with regard to SDLT, as to whether the transfer to the company can be brought about without a possibly unbudgeted tax charge. 

With LLP’s, by contrast, the rules are fairly black and white and don’t depend on the interpretation of some fairly vague words like ‘business’ and ‘partnership’.

Possibly the clinching argument as far as the choice between a property investment company and a property investment LLP is concerned, however, is that relating to the long-term treatment of companies owning appreciating assets. Where a company disposes of an investment property at a gain, it has a charge to corporation tax on that gain. If the shareholders wish to take the money out of the company, there is then a second charge, which could give you a very high overall effective rate of tax on that gain. 

By contrast, LLPs only involve one layer of tax on sale of a property; moreover, where family members die and pass on their interests to the next generation, there is a CGT-free uplift of the base cost of the properties; something which doesn’t happen where you hold property through a company. 

In summary, I would be so bold as to say that in most cases now an LLP is a preferable alternative to the limited company as a way of providing structure and flexibility of income allocation between family members.