Do you want to take control and manufacture a BMV type transaction without having to wait for vendors to approach you?
If so, then you will be interested in a method of transaction whereby you purchase a freehold building in the name of your company and then split it into separate leasehold flats, thereby maximising the full value of the property.
If set up correctly, the right deal can allow you to purchase blocks of flats with the potential of withdrawing cash from the transaction and be left with equity in the property. So how does it work?
There are three methods of pursuing these types of transaction, but each requires you to find a building for sale held on a single freehold title, which is already split into flats and which are either occupied on Assured Shorthold Tenancies, or are vacant.
The basic principle of how the transactions work are that you will own individual leases of flats within the building which you can re-mortgage to 85% of their value and your company, or partner, will own the freehold of the entire block. The reason for the split is that collectively a house split into leases will yield a greater value (and therefore re-mortgage potential) than the house on its own.
Whereas previously these deals could be achieved without the need for paying a deposit, by way of the utilisation of bridging finance and simultaneous re-mortgage products, a deposit is now required, but it still provides a neat way in which to draw out equity from a property that would otherwise be locked in.
Option 1 – Click here for diagram
The first method of purchasing is to set up a company (or indeed to use an existing company that you own) (“X Ltd” in the attached example), which will purchase the freehold of the building from the vendor and then grant leases of each individual flat to you to hold in your personal name. The freehold purchase and the granting of the leases is carried out simultaneously and therefore you (as the individual) (“Mr A” in the attached example) will fund the purchase of the leases by way of mortgages and deposits. These monies will be paid to X Ltd to utilise in purchasing the freehold. The purchase of the leases will be at full market value and not a split of the freehold purchase price and therefore X Ltd will make a profit on which it will be subject to corporation tax. Provided that X Ltd is owned by MrA then this (post tax) profit can be withdrawn from the transaction by way of a dividend (on which Mr A will be subject to personal income tax) or otherwise, X Ltd could retain the monies and utilise it in the next transaction.
As a variation to Option 1 instead of Mr A purchasing the leases from X Ltd at full market value, these could be purchased at the actual split of the freehold purchase price. This way X Ltd will not make a profit and therefore Mr A’s larger proportion of equity in each leasehold property could allow Mr A to remortgage after the mortgage company’s fixed restricted period (often 3 or 6 months) to 85% of each leasehold property’s true market value, thereby realising the maximum potential of each flat.
Pitfalls
The potential pitfalls for Option 1 are:
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If the freehold purchase value is £125,000 or higher, then Stamp Duty Land Tax (SDLT) will be payable by X Ltd and if the combined value of the leasehold properties is £125,000 or higher, then Mr A will also have to pay SDLT as the granting of the leases by X Ltd to Mr A will be seen as linked transactions. For example – if the deal includes a house (sold for £150,000) with two flats (each lease will be granted for £75,000), SDLT will be payable by X Ltd at 1% of the purchase price (£1,500) and Mr A will pay SDLT at 1% of the combined lease premiums (£1,500). Double SDLT of £3,000 will therefore be payable.
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If X Ltd is owned and/or controlled by Mr A then, whichever of the two variations of Option 1 are used, for tax purposes HM Revenue and Customs will deem the grant of the leases to be at full market value and not simply at the split of the freehold purchase price. For example – Using the figures above, if the market value of each lease is £90,000, this will produce a profit of £30,000, on which X Ltd will be subject to tax (Combined Lease Value (2x£90,000) = £180,000 less Purchase Price of £150,000 = £30,000 profit).
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As X Ltd and Mr A are connected persons, this must be reported to Mr A’s mortgagee.
Option 2 – Click here for diagram
The second method of purchasing is to agree with the vendor that they will grant the leases (normally at your cost) to you (“Mr A” in the attached example). The purchase price is split between the individual leases and Mr A will then purchase the various leases in the building. Simultaneously with the grant of the leases to Mr A, the vendor will sell the freehold (which is then subject to the long leases in your favour) to your Company (“X Ltd” in the attached example) at a nominal value. Mr A will purchase the leases by way of deposits and mortgages and then re-mortgage them following the expiry of the mortgagee’s restricted period (often 3 or 6 months) to 85% of their market value, thereby realising the maximum potential of each flat.
Pitfalls
Using this method, Mr A will not have to pay double stamp duty or have the potential of an extra tax burden, but the potential pitfalls for Option 2 are:
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Proceeding in this way is likely to tip off the vendor as to the possibility of re-financing himself to draw cash out of the property. Requesting that the vendor grant leases to Mr A directly (rather than through X Ltd without his knowledge as at Option 1 above) may result in the vendor pulling out of the deal altogether.
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As the freehold sale takes place after the leases to Mr A individually have been granted, the Landlord and Tenant Act 1987 requires the Landlord (the Vendor) to serve notice on the Tenants (Mr A) of the proposed sale to the Purchaser (X Ltd) offering the Tenants the opportunity to purchase the freehold on the same terms as the proposed sale to the Purchaser. The notice must give the Tenant a period of 2 months within which to elect to purchase, if they so wish. If the Landlord fails to serve this notice then he will be committing a criminal offence, and therefore it is unlikely that a Vendor will take a view and sell without going through the notice procedure.
Option 3 – Click here for diagram
The final method of purchasing is to utilise an unconnected Company (“Y Ltd” in the attached example) to purchase the freehold from the vendor. That unconnected company will then grant the leases to you individually (“Mr A” in the attached example) and Y Ltd will then sell the freehold (subject to the leases in Mr A’s favour) to your Company (“X Ltd” in the attached example). Mr A funds the purchase of the individual leases by way of deposits and mortgages. Following the expiry of the mortgagee’s restricted period (often 3 or 6 months) Mr A can then re-mortgage each flat to 85% of its value, thereby realising the maximum potential of each flat.
Pitfalls
As Mr A does not own or control Y Ltd, the potential tax problem mentioned with Option 1 above does not arise, but the potential pitfalls for Option 3 are:
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It is necessary to ensure that Y Ltd is not making a profit (other than fees) in the transaction, or indeed an artificial loss. Therefore the leases must be granted for an apportionment of the freehold purchase price, which will result in double SDLT being payable. It is not therefore possible for the leases to be granted at a nominal premium, as this would result in Y Ltd having sold the leasehold interests for a much lower sum than the freehold purchase price thereby making an artificial loss. For example, utilising the figures stated in the above examples Y Ltd will incur stamp duty on the purchase price of £150,000 at a rate of 1% (£1,500). Mr A will be required to reimburse this to Y Ltd. The leases granted to Mr A will be linked transactions for SDLT purposes and therefore duty will be payable on the collective value at 1% (£1,500). The subsequent sale between Y Ltd and X Ltd will be at a nominal value (as the freehold will be subject to the leases in Mr A’s favour) and therefore will not incur stamp duty.
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As Y Ltd and Mr A are not connected persons there is no relationship that requires to be reported to the mortgagee.
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This method will incur an extra layer of legal fees, as Y Ltd must instruct its own solicitors independent of Mr A’s and X Ltd’s solicitors.
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Mr A must also find an unconnected Company (Y Ltd) willing to act in the required manner for this transaction. If you require us to assist you in this manner then please contact us.
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As above at Option 2, there are potential difficulties in respect of serving notices pursuant to the Enfranchisement Legislation.
General Observations
These transactions are costly. In addition to standard conveyancing fees on your purchases of the leases, you will incur additional legal fees for the acquisition of the freehold and the drafting of the leases, and if Option 3 above is utilised then a third set of legal fees will be required to act for the unconnected Company.
It is therefore imperative that you ensure that the figures stack up, that there is sufficient profit in the transaction to cover these fees and the other expenses that will be incurred, in order to make the transaction worthwhile.
Once you have found a property and ensured that the figures are such that the transaction is worth pursuing, you must instruct a plans draftsman to produce floorplans, which are to scale and in compliance with the Land Registry’s requirements. If you require us to suggest a suitable company to assist you in this regard then please contact us.
To enable us to draft the leases, we will need you to provide us with basic information, such as whether there is parking at the property and if so which flats have the benefit of this, or whether it is communal on a ‘first come first served’ basis. If the property is a converted house, there is often a garage and you must therefore decide which flat is to have the benefit of using the garage. If there is a garden, who can use this and for what purposes. Whilst the leases will initially be held by you and your Company will be the landlord, you must still provide for ground rents and service charges in the lease, not only to comply with mortgage requirements, but also to ensure that the leases can be sold on in the future. A market rent should therefore be included together with standard service charge provisions. You should also ensure that there is documentary evidence of the service charge and rent being collected, as this will be required by a prudent purchaser on any future sale.
Fees
Options 1 and 2
Mr A will incur legal fees of £750 plus VAT and disbursements (searches etc) per lease that is purchased.
X Ltd will incur legal fees of £750 - £1,000 plus VAT for the drafting of the leases. The level of fees depends upon the number of flats in the block to be granted.
X Ltd will also incur legal fees of £750 plus VAT in the freehold acquisition of the block.
Option 3
If you utilise Option 3 above then an additional set of legal fees will be incurred by the independent solicitors acting for Y Ltd. The level of these fees will therefore depend upon the solicitor being instructed.
X Ltd will still incur a freehold acquisition fee as the transaction will require to registration at the Land Registry, but as this will be a nominal transaction, these fees will ordinarily be £350 plus VAT and disbursements
In addition to the above you will also incur SDLT at the applicable rates, whatever option you utilise.
Conclusion
The above is a summary of how these types of transactions work. We cannot provide any advice on taxation liability and any referral to taxation above is general commentary in this regard. You should always consult an accountant or tax specialist to advise on potential tax liability before embarking on transactions of this nature.
If you have any queries on how these transactions work, or if you wish to proceed with a transaction of this kind then please contact Stewart Matthews on 01908 304560 or by email smatthews@neves-solicitors.co.uk.
