Many Irish landlords may be using property ownership structures which have become outdated and need to be reviewed and updated.
These structures were designed for a very different tax and property landscape. At the time, the typical property ownership model was built on the premise that it was better to hold property personally, so that the profit on sale was only liable to one charge -- capital gains tax, then 20pc.
During the period of personal ownership any rent received could be sheltered from tax by a mixture of interest payments and property tax shelters such as Section 23 relief or capital allowance schemes.
The use of these tax shelters meant that in many instances there was no annual tax cost from the investment. Consequently, the gross rent would have been available to meet banking and other commitments.
In many instances, the banking arrangements were structured as interest only borrowings.
As we all know only too well, since 2007 the Irish property market has gone through tumultuous change. Property values have plummeted. The very difficult economic environment has been made even worse as a result of far-reaching taxation changes which have taken place over the period.
The tax changes may be broadly summarised as follows:
Restrictions on high earners
The "high earner" restriction on the claiming of property tax shelters, first introduced in 2007 and amended in 2010, now has the broad impact of limiting the annual claim for tax based property reliefs to €80,000 or 20pc of income (if greater).
This has the effect of imposing an effective income tax rate on rental profits of up to 33pc. The rate is increased to 47pc when PRSI and the Universal Social Charge (USC) are factored in. Prior to 2007 it was possible to achieve a 0pc effective tax rate on rental income.
Phasing out tax shelters
The Finance Bill 2012 has introduced measures which will, over time, have the impact of eliminating all capital allowance based tax reliefs.
Section 23 type reliefs, on the other hand have not been abolished.
The proposed measures will mean that most capital allowance schemes will terminate in 2014 and the benefits of any unused allowances will be lost.
Where the "tax life" of a particular scheme extends past 2014 then the claim for tax relief will continue until the end of its "tax life".
The phasing out of these capital allowance schemes will result in additional taxes becoming payable for 2015 and subsequent years.
5pc levy on property tax reliefs
The Finance Bill 2012 has introduced a 5pc levy on individuals with incomes in excess of €100k. The levy applies to any property-based tax reliefs claimed.
Restriction on interest relief for rented residential properties
The measures, which were introduced in 2009, limit the amount of interest allowable to 75pc.
General tax rate increase and the introduction of the USC
Over the period, marginal tax rates have increased from 46.5pc to 55pc. These rates include the USC introduced in 2011 which has the added impact of applying to rental profit before deduction of capital allowances.
The above table highlights the changes in the after tax position of a landlord between 2006 and 2015.
Action to be taken
Landlords should review their property structures and prepare cashflow projections for the years to 2014 and beyond.
When preparing such statements, they should stress test the levels of rental income, and the levels of expenditure such as banking commitments, allowing for potential interest rate movements.
The tax changes as outlined above will also need to be factored in.
Typically these will show dramatic increases in the tax costs for the years to 2014 and further again for 2015 and subsequent years.
This has meant that in certain circumstances the taxation cost of holding property investments in the current ownership structures no longer make commercial sense.
As a consequence, investors need to look at alternative ownership structures such as investment companies, trading businesses or other investment structures.
When transferring any investment, care will need to be taken to ensure that the transfer is taking place at market value, otherwise negative taxation consequences can arise.
In addition, it will be necessary to manage the clawback of any tax reliefs previously claimed. Transaction costs such as stamp duty and legal costs will need to be considered, together with the impact on any banking arrangements.
While there is no "one size fits all" solution in developing the appropriate structure for holding property investments, there invariably are opportunities to save tax and provide the property owner with a greater level of security and certainty as regards the viability of their investments.
Experience shows that lenders are generally agreeable to accommodate ownership change which improves the tax position, as this will enhance the value of their security.
It is important, however, that any proposals are well thought through in advance so that negotiations with the bank are conducted calmly, in the context of likely mutual benefit, rather than in the pressure cooker atmosphere which will apply if the borrower postpones addressing the issues until it is too late.
Tim O'Rahilly is tax partner, PwC